July Brings Some Relief

Both stock and bond markets rallied in July despite economic data that reflects softening conditions and continued high inflation. Investors were encouraged by company earnings reports that showed a less bleak picture than feared. Overall, while we are certainly not out of the woods completely, the trend in July was better than the difficult markets experienced year to date through June.

Stock markets staged a rally in July with the S&P 500 and Nasdaq up more than 9% and 12% respectively. International stocks were mixed as developed markets were positive while emerging markets were slightly negative. Despite the significant rally during the month, both US and International markets have had negative performance over the past year.

Bond markets experienced a rally in July as well, with the Bloomberg Barclays Aggregate Index up over 2%. The performance was driven by a precipitous decline in the 10-year US Treasury Rate which fell from a recent high of 3.49% on June 14, 2022 to 2.67% by the end of July1. When interest rates are declining, bond prices typically rise. Similar to the stock market, the bond price rally in July was strong, but the yearly performance is still negative as interest rates remain significantly higher than this point last year.

With regard to the economy, the early data on inflation in July was not promising. The inflation rate came in at 9.1%, a new 40-year high2. Inflation remains the number one concern of investors, but the recent discussion points have shifted. The concern isn’t as much regarding demand and the elevated prices themselves, but rather how these price increases will slow demand while the methods used to control inflation (raising interest rates) will be so aggressive that it will send us into recession. This concern was further exacerbated by the most recent GDP report, which showed a second straight quarter of decline3. This is not the official determinant of a recession, but two quarters of GDP decline has been a rule of thumb to reflect past recessions.

Contrary to economic data, corporate earnings have been a little better than expected and certainly better than the sentiment of investors going into earnings season. As of 7/29/22, 56% of the S&P 500 companies have reported earnings for the second quarter. Of the companies that have reported, 73% have exceeded their estimates of earnings for the quarter. Currently, the expectations for earnings growth in 2022 and 2023 are 9% and 8% respectively4. If this growth rate proves accurate, this is a relatively healthy backdrop for stocks.

In short, there are currently conflicting signals between trends in the economy and the trends in corporate earnings. Also, after a period of significant decline and subsequent rally, there are always questions about whether this was the beginning of a new bull market or just a short pause in a prolonged bear market. While we never know with certainty ahead of time, there are early signs that give us some hope for the future. Price declines for things like gasoline, corn, and wheat – which have a direct influence on consumer pocketbooks – are a positive sign for consumer’s ability to continue to spend to support the economy. We continue to listen to company analysis on their current earnings but, even more importantly, what they are discussing with regard to outlooks for the remainder of the year. Lastly, we are watching for any changes to a strong job market and the effects of pricing on consumer behavior.

Even if this period is determined as a recession or not, stock market investors are always focused more toward the future than the past. While we never know the absolute bottom in advance, history would tell us that the companies in the US market are adaptable, efficient and have weathered storms in the past and come out stronger on the other side. Therefore, investors who are patient, prudent, and have a well-defined investment plan are rewarded over the long term.

https://fred.stlouisfed.org/series/DGS10
https://www.cnbc.com/2022/07/13/inflation-rose-9point1percent-in-june-even-more-than-expected-as-price-pressures-intensify.html
https://finance.yahoo.com/news/q-2-us-gdp-gross-domestic-product-economic-activity-123214911.html
https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/
Earnings%20Insight/EarningsInsight_072922.pdf

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on August 9, 2022 Read More

April Showers Rain on the Markets

April 2022 was not kind to either bond or stock holders.  Stocks were down significantly, and in what has been a pattern this year, bond markets did not provide any relief and were down as well.  The predominant concern of the market remains inflation and is causing consternation regarding future economic health, the consumer’s ability to spend, and the actions of the Federal Reserve needed to control rising prices. 

The S&P 500 index was down 8.72% in April, the worst month of performance since March 2020.1 Many of the underlying stocks have experienced performance far worse than the overall markets in 2022, especially stocks in the once high-flying growth space.  Companies that were considered beneficiaries of the COVID shutdown have experienced a very difficult 2022, with companies such as Peloton (PTON), Zoom Video Communications (ZM), Netflix (NFLX), and Teladoc (TDOC) each down 45% or more year to date.2 

Bonds, once again, failed to provide respite from the difficulties in the stock market.  The Barclays Bond Aggregate Index (a widely used measure for the bond market) was down 3.79% in April and is now down 8.51% in the last 12 months.  The bond market just experienced the worst quarter in 20 years4 and April continued on the negative trend.  The most significant factor regarding bond weakness has been rising interest rates.  Over the past year, the 2-year US Treasury rate has risen from 0.16% to 2.70% while the 10-year US Treasury rate increased from 1.65% to 2.89%.  Rising rates have a negative influence on bond prices.  Also, income generation from bonds were near all time lows in 2020 and 2021, which has left very little income to offset the price declines. 

The source of nearly all market concerns is inflation.  Rising prices, especially unconstrained rising prices, have a ripple effect across the economy and markets.  For the economy, higher prices may create less ability for consumers to spend on things they want because the things they need (like gas and food) are more expensive.  For companies, material costs and employee wages are rising due to high demand and low supply, which can have a negative impact on corporate earnings.  Lastly, the actions to control inflation, usually done by the US Federal Reserve, also have a side effect of stifling growth and potentially causing a recession.  Because inflation has been sustainably higher than anticipated, markets are responding to these events with caution.  Bonds sell off because of the fear of continually rising interest rates and stocks sell off because inflation and subsequent Fed actions to control it could cause a future recession. 

With all of this, we still have a relatively positive outlook from this point forward due to:

  • A strong consumer that continues to show high demand for things like travel and restaurants
  • Supply chain effects may alleviate to naturally lower the inflation rate as the year progresses
  • Company earnings are still expected to grow by nearly 10% in both 2022 and 20233

If these fundamentals remain intact, the market decline into correction territory could provide an opportunity to add value and increase returns over the long term.  While markets certainly have declined, the greatest damage was done in stocks with severely inflated valuations that have now come back to earth.  High-quality companies that have receded despite no significant change to their earnings profile are now trading more cheaply than they have been over the past few years. 

In short, it is our expectation that the market can stage a second half rally unless inflation continues to accelerate.  We expect inflation readings to continue be elevated in the near term, but the inflation rate will reduce as we progress through the year.  Lastly, we believe the Federal Reserve will raise interest rates, but much of the damage done in the bond market may have been done already. 

Therefore, our recommendation is to remain within the scope of your investment plan and don’t completely avoid risk for safety.  However, this is also not a time to overload on risk as there remains several economic unknowns, volatility remains high, and stocks aren’t cheap.  However, for those investors that have held assets aside “for a rainy day”, investing a portion of that capital for long term higher returns may prove opportunistic at current market levels. 

1https://www.washingtonpost.com/business/2022/04/29/markets-wall-street-april/
2stockcharts.com
3https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_042922.pdf
4https://www.morningstar.com/articles/1087132/13-charts-on-the-markets-first-quarter-performance

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on May 3, 2022 Read More

Inflation is Driving the Bus

As the markets closed the first quarter, one item of concern was above all others: inflation.  Persistently higher prices across nearly all categories is creating ripple effects that caused a pause in the strong markets seen since March 2020.  Markets were able to rally off the low point as March was a positive month for stocks.  However, March continued the trend of difficulty for bonds and the historical safe haven actually underperformed stocks during the first quarter of 2022.  As we look to the remainder of the year, the market will continue to grapple with higher prices, but the degree to which those prices accelerate or decelerate will be one of the key determinants of market direction. 

With regard to inflation, the US economy has prices rising at the fastest rate since the 1980’s.  The Consumer Price Index, a widely used measure of price change in the US, rose by 7.9% in February.  This high level of price increases is being felt across the board by US consumers: at the gas pump, at the grocery store, when they buy a vehicle and certainly when they buy a home.  As the Russian/Ukraine conflict escalated, this exacerbated price increases as Russia is a major energy supplier for the European Union. 

The ripple effects of rapidly rising prices can be felt in many areas.  First and foremost, the US Federal Reserve has shifted from supporting growth to controlling inflation.  The most widely known tool of the Fed is changing the Fed Funds Rate, which in March was raised for the first time since 2018.  Further, commentary from the Fed Governors, including Chairman Jerome Powell, gave suggestions that the Fed will continue on the path of raising interest rates at future meetings and potentially accelerate the levels more aggressively to curb inflation. 

The effects of an adjusting Fed can be seen in US Treasury rates.  The 2-year US Treasury rate rose from 0.73% at year end 2021 to close March at 2.28% while the 10-year US Treasury rate rose from 1.52% to 2.32%.2 As interest rates rise, bond prices fall.  Further, when bonds are producing very little income, there is little buffer to offset the price declines.  As we have been saying for some time, bonds simply are unattractive during periods of low rates that are expected to rise, and that is what we are facing now.  Bond markets, as measured by the iShares Barclays Aggregate ETF, actually underperformed stocks during the quarter.  Bonds and stocks both finishing a quarter negatively is a relatively rare occurrence and the last instance was the first quarter of 2018. 

The concern among stock investors is that rising prices, and subsequent actions by the Federal Reserve, will cause a significant slowing of economic growth and potentially a recession.  A widely looked at marker for potential future recession is an inversion of the yield curve, which simply means shorter term (2-yr) Treasury rates are higher than longer term (10-yr) rates.  A sustained inversion of the yield curve has typically preceded recessions, but the timing is fairly wide at anywhere from 6 to 24 months.  In March, the yield curve did invert for the first time since 2019. 

As we look to the remainder of the year, prices will remain the primary factor to watch.  Any reduction in the rate of inflation may induce the Fed to remain prudent and patient and reduce the potential of shocking the economy into recession.  However, a sustained level of highly elevated prices is negative for nearly all asset classes with the potential exception of gold and other commodities. 

Our outlook is still relatively positive on stocks.  Even though the probability of recession is rising, we feel that a recession in 2022 is still quite low.  Estimated earnings growth for 2022 remains around 9% this year3, and while markets are not cheap, valuations are lower than the elevated levels seen in the fall of 2021.  With regard to bonds, the rise in current rates means that new investors in bonds are actually receiving some level of income for their allocation.  While the level of income still significantly trails inflation, the absolute level of income is higher now than it has been since early 2020.  There are better opportunities in bonds now, coming off the worst quarter in the last 20 years4, but this wouldn’t be an area which we would be adjusting allocations aggressively. 

Lastly, volatility has made its way back into the markets after a relatively sanguine 2021.  Remember that volatility and uncertainty in the market is the norm, while times of high returns and low volatility tend to be the exception.  Expect markets to continue to be volatile in the near term as price concerns will likely remain with us for some time.  As always, stay invested for the long term and within the strategy set forth in your personal investment plan.  Safe assets have a place in portfolios to protect assets during times of volatility, but growth assets have a place to outpace long-term inflation and grow your overall asset base.  Keeping a proper balance of growth and safe assets to fit your personal objectives and within the barriers of your risk ability and tolerance remain the best way to achieve the goals for your money. 

1https://www.bls.gov/cpi/
2https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2022
3https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_040122B.pdf
4https://www.morningstar.com/articles/1087132/13-charts-on-the-markets-first-quarter-performance

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on April 4, 2022 Read More
 
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