by Clare Market Investments on May 2, 2022
Monthly Market Summary
- The S&P 500 Index produced a -8.8% total return during April, slightly outperforming the Russell 2000 Index’s -9.9% total return.
- Consumer Staples was the only S&P 500 sector to produce a positive return during April’s market selloff. Energy was the second-best performing sector as the price of crude oil traded around $100 per barrel. In contrast, the ‘Growth-style’ sectors, including Communication Services, Consumer Discretionary, and Technology, each traded more than -10% lower as interest rates soared higher.
- Corporate investment grade bonds generated a -6.7% total return, underperforming corporate high yield bonds’ -4.2% total return.
- The MSCI EAFE Index of global developed market stocks returned -6.7% during April, underperforming the MSCI Emerging Market Index’s -6.1% return.
Federal Reserve Policy Remains a Headwind for Equity & Credit Markets
April was another difficult month for both stock and bond markets. The S&P 500 Index traded -8.8% lower during the month, while the Bloomberg Bond U.S. Aggregate Index traded -3.8% lower. Federal Reserve policy remains the driving force as the central bank raises interest rates and prepares to shrink its balance sheet to ease inflation pressures. It is a difficult and delicate balancing act to pull off. Low interest rates and bond purchases stabilized the U.S. economy during the Covid pandemic but removing the two pandemic-era monetary policies is proving to be enormously disruptive.
Interest rates rose again during April as the 10-year U.S. Treasury yield surged +0.57% to 2.89%. While 0.57% may seem small on an absolute level, it significantly impacts how investors position portfolios. Why? Interest rates represent the cost of money and are used as an input to value company shares. A higher Treasury yield offers investors a higher rate of return. To incentivize investors to own riskier assets, such as stocks, the expected return must increase. Buying an asset, such as a house or stock, at a lower valuation should increase the expected return, which means the theoretical value of the asset should be lower as rates rise. On a conceptual level, this is the messy valuation process the market is currently working through. It is trying to find the correct theoretical fair value of a company’s shares as interest rates rise. This is in addition to dealing with geopolitical tensions, new Covid lockdowns in China, and surging inflation.
“…so, apart from all that, Mrs. Lincoln? How was the play?”
GDP Unexpectedly Declines in the First Quarter
The Bureau of Economic Analysis reported that real gross domestic product decreased at an annual rate of 1.4% in the first quarter of 2022. In the fourth quarter of 2021, real GDP increased 6.9%. So, things are certainly slowing down – and quickly. The good news is that personal consumption has so far remained strong, coming in at 2.7%.
Builder Confidence Declines for 4th Month in a Row
The National Association of Home Builders announced that Builder Confidence for newly built single-family homes moved two points lower to 77 in April. This is the fourth straight month that builder sentiment has declined. Despite low existing inventory, builders report sales traffic and current sales conditions have declined to their lowest points since last summer as a sharp jump in mortgage rates and persistent supply chain disruptions continue to unsettle the housing market. Policymakers must take proactive steps to fix supply chain issues that will reduce the cost of development, stem the rise in home prices and allow builders to increase production.
The housing market faces an inflection point as an unexpectedly quick rise in interest rates, rising home prices, and escalating material costs have significantly decreased housing affordability conditions, particularly in the crucial entry-level market.” Furthermore, mortgage interest rates have jumped more than 1.9 percentage points since the start of the year and currently stand at 5%, the highest level in more than a decade.
According to the latest Producer Price Index reported by the Bureau of Labor Statistics, the prices of goods used in residential construction ex-energy climbed 1.4% in March, following an upwardly revised increase of 2.2% in February and 4.1% in January. This adds up to an 8% jump in building materials prices since the start of 2022.
Earnings Holding Up Ok… For Now, Anyway
As of the last day of the month, 55% of the companies in the S&P 500 had reported earnings for Q1 2022. According to research firm FactSet, “80% have reported actual EPS above estimates, which is above the five-year average of 77%. In aggregate, companies are reporting earnings that are 3.4% above estimates, which is below the five-year average of 8.9%.”
Looking ahead, analysts expect earnings growth of 5.5% for Q2 2022, 10.9% for Q3 2022, and 10.5% for Q4 2022.
For calendar year 2022, analysts are predicting earnings growth of 10.3%.
The forward 12-month P/E ratio is 18.1, which is below the five-year average (18.6) but above the 10-year average (16.9). It is also below the forward P/E ratio of 19.4 recorded at the end of the first quarter (March 31), as prices have decreased while the forward 12-month EPS estimate has increased over the past month.
What Should We Expect Moving Forward?
There is no easy answer or definitive answer to this question. This year’s selloff indicates that some degree of tighter Federal Reserve policy is already priced into the market – we just do not know how much. But, the list of market uncertainties remains long, including corporate earnings, economic strength, and the path of Federal Reserve interest rate hikes. Until the market receives clarity on these uncertainties, volatility is likely to remain elevated. Stay focused – and buckled up. The bumpy ride may not be done yet.
Clare Market Investments, LLC is a Registered Investment Advisor. This material is for informational purposes only. It is not intended as and should not be used to provide investment advice and is not an offer to sell a security or a recommendation to buy a security. This summary is based exclusively on an analysis of general market conditions and does not speak to the suitability of any specific proposed securities transaction or investment strategy. Judgement or recommendations found in this report may differ materially from what may be presented in a long-term investment plan and are subject to change at any time. This report’s authors will not advise you as to any changes in figures or views found in this report. Investors should consult with their investment advisor to determine the appropriate investment strategy and investment vehicle. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. Except for the historical information contained in this report, certain matters are forward-looking statements or projections that are dependent upon risks and uncertainties, including but not limited to such factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle. See claremarket.com for additional information and disclosures. © 2022 Clare Market Investments, LLC
“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd nor against the crowd.”
- Warren Buffett