The Navigator | May 2022
The US stock market sank in April with the Nasdaq falling 13.0% ‒ its worst monthly performance since October 2008. The S&P 500 lost 8.8% ‒ that index’s worst month since March 2020. Similarly, the Dow Jones Industrial Average was down 4.9% on the month. The slowing economy, a hawkish US Central Bank, surging inflation, ongoing Russia-Ukraine War, China Covid lockdown, and mixed first-quarter earnings reports have all contributed to the market’s sell-off.
Markets are being weighed down by lingering fears over persistent inflation and concerns over whether tighter monetary policies might derail the economy. Energy and other commodities continued to drive robust inflation data. On a year-ago basis, the headline March CPI was up 8.5%, the strongest since the early 1980s. Meanwhile, core CPI softened more than expected and was up 6.5% on a year-ago basis in March, driven in part by the sharp price decline in used cars. However, we believe it is too early to draw a conclusion about moderating core inflation and believe that the risks remain to the upside, driven partially by potential supply issues derived from the Russia-Ukraine conflict.
We expect the Fed to remain hawkish given accelerating inflation pressures in energy and food, with risks that these pressures could spill over into higher inflation expectations. Speaking at an IMF-hosted event, Fed Chair Jerome Powell said that a 50-basis points hike could be on the table at the May policy meeting where he stated that, “it is appropriate…to be moving a little more quickly.” Investors are pricing in over 240 basis points of tightening for the rest of this year.
Investors were also worried about lockdowns in major cities in China such as Shanghai and Beijing, with fears those might exacerbate the already extensive disruptions to global supply chains and intensify inflationary pressures. It looks like developments over the past few weeks suggest a moderate disruption (versus the major disruption in early 2020). The latest high-frequency data also indicated some progress with new cases beginning to decrease, the portion of high to medium-risk cities declining, and manufacturers in Shanghai gradually resuming production.
April also demonstrated some solid overall earnings so far this season, but disappointing reports from mega-cap companies such as Netflix and Amazon led to plunging share prices. About 80% of S&P 500 companies beat earnings estimates, with about 55% of companies reporting. In the aggregate, companies are reporting earnings that are 3.4% above estimates, which is well below the five-year average of 8.9%. At the same time, diverging earnings from mega-cap companies fueled wild swings in the market. On the last trading day of the month, Amazon sunk about 14% after the e-commerce giant reported a surprise loss and issued weak revenue guidance for the second quarter.
Some recent data showed evidence of resilient economic activity with strong March indicators for industrial production and housing starts complemented by an unexpected improvement in April consumer sentiment. However, the most significant data surprise may have been the advance estimate showing that GDP fell 1.4% in the first quarter. Trade was a substantial drag on growth (net export down by 3.2%), with the Russian invasion of Ukraine contributing in part to the massive pain. While consumer spending (up 2.7%) and business investment (up 7.3%) are still solid, we believe GDP growth will be slower this year than last year with a slew of headwinds around tightening monetary policies and geopolitical risks.
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↓ Valuation | The S&P 500 posted a monthly loss of 8.8%, with valuations for equity improving but remaining negative. P/E: decreased from 23.3 at the end of March to 21.2 at the end of April; Forward P/E: fell from 20.1 at the end of March to 18.1 at the end of April. Inflation-adjusted valuation metrics continued to be negative with inflation rising.
↔ Sentiment |The U.S. manufacturing condition remained solid, with the ISM manufacturing index staying well above the neutral level of 50. However, the index fell to 57.1 in March from 58.6 in February, with lingering supply-chain issues and uncertainty around the geopolitical conflict. According to the University of Michigan survey, U.S. consumer confidence rebounded in April to 65.2 from 59.4 in March, led by rising expectations. Nonetheless, the index remains relatively low with high gasoline prices, surging inflation, and a deteriorating stock market. Homebuilder confidence slipped 2 points to 77 in April. Higher interest rates reduced buyer affordability, and rising builder costs continued to push down the sentiment.
↑ Technical |Technical indicators were positive as the VIX “fear index” and reversal indicator outweighed momentum indicators. The S&P 500 was 8% below its 200-day moving average, 8% below the 100-day average, and 6% below the 50-day average. VIX: spiked to 33.4 at the end of April compared with20.6 at the end of March. Volatility resurged in April amid concerns over tighter Fed’s policy, persistently high inflation pressures, geopolitical risks and Covid lockdowns in China.
↑ Macroeconomic |The labor market remained tight as the pandemic continues to recede, with payroll employment increasing by 431,000. Inflation remained elevated with the headline and core CPI up 8.5% and 6.5% on a year-ago basis, respectively. Meanwhile, the Producer Price Index for final demand rose more than anticipated in March, increasing 1.4%. Retail sales appeared healthy (up 0.5%) but remained weak in March with rising prices largely attributing to the gains. On the other hand, industrial production expanded 0.9% in March, a larger gain than consensus estimates.
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As of 4/30/2022
1 Source: Bloomberg, NorthCoast Asset Management.
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