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

Geopolitical Risks Come to the Forefront

Markets faced a second straight month of declines as geopolitical fears combined with existing inflation concerns increased market volatility and led to a rise in fear-based selling.  Stock markets are now firmly in correction territory from the all-time highs seen on January 3rd, 2022. 

The main issues facing investors right now are increasing risk from rising prices (inflation) and geopolitical events (Russia/Ukraine conflict).  The issue is that these are somewhat correlated as well.  Because of the economic sanctions and restrictions imposed on Russia, as well as the continuing effect on Ukrainian exports, commodities such as wheat and oil may continue to rise in price.  This exacerbates the inflation already present in many goods and services due to high demand and limited supply.  When you combine these concerns with the near certainty of the US Federal Reserve increasing interest rates to combat inflation, there is question as to how much the US economy and consumers can handle. 

Despite these issues, not all the news in the markets has been bad – some news remains quite positive:

  • COVID cases, hospitalizations, and deaths are falling dramatically
  • Restrictions as a result of COVID are declining, which should begin to reduce supply constraints
  • Economic growth, employment, and the US consumer remain relatively healthy
  • The US has little to no reliance on Russian oil or gas
  • The majority of S&P 500 companies have reported earnings that exceeded expectations
  • Earnings growth projections for 2022 remain in the 8-10% range and companies are healthy

At the beginning of the year, we communicated that one of our caution flags for 2022 was the valuation of the market.  Simply put, stocks were expensive.  As a result of this correction, and the limited change to the fundamental forecasts, stocks are now cheaper than they were at the beginning of the year.  Now, could stocks continue to fall and get even cheaper?  Absolutely.  Stocks are coming down from elevated levels, but they still are not cheap.  Time will tell if valuations continue to decline for the markets, but the price paid for stocks is more reasonable now than three months ago. 

Another area we are seeing higher than average volatility is the bond market.  Bonds typically provide ballast against stock market declines as investors look to bonds for safety when stocks are not working.  This hasn’t been the case in 2022 as inflation and economic growth provide upside pressure to interest rates.  When interest rates rise, bond prices fall.  Furthering the difficulty in certain bonds is the elevated fear levels in the market, and investors during these times require higher premiums to take on default risk (called the credit spread).  At the end of the year, credit spreads were near all time lows as there was little evidence of economic concern.  Since that time, these spreads have been rising which also put pressure on bond prices. 

Overall, most traditional investments have been challenging in 2022.  Outside of precious metals like gold, there hasn’t been a lot of areas for investors to achieve positive returns year to date.  These trends don’t last forever but can be painful when we are going through them. 

These times are the most important to have a sound investment plan that incorporates both safety and growth assets.  Times of high volatility usually means greater positive and negative swings and increased emotion as a result.  Being concerned and emotional regarding investments is absolutely normal and should be expected.  However,  avoiding irrational action based on those emotions is the key to achieving your long term objectives. 


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 March 2, 2022 Read More
 
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