The Navigator | April 2022
The major equity benchmarks ended higher in March, reclaiming some of the ground lost over the first two months of the year. The S&P 500 and Nasdaq finished the month up more than 3% each with the Dow adding 2.5%. A continued rise in many commodity prices boosted the energy and utility sectors while financial shares underperformed. Financials were dragged lower in part by a flattening yield curve as banks tend to profit from larger spreads between short-and long-term rates.
Despite the March rebound, investors still seem concerned about two major growth risks against a backdrop of historically high inflation: the prospect of Fed policy changes and a global energy shock (especially in Europe) due to geopolitical risk.
We believe that the Fed tightening risk remains the most substantial headwind for the equity markets. As widely expected, the Fed kicked off its hiking cycle at the March meeting by raising its short-term lending rates by 25 basis points, moving the fed funds target rate from near zero to a range of 0.25% to 0.50%. It was the first hike by the Central Bank since 2018, representing a shift from its ultra-accommodative monetary policy. According to the median projections, policymakers are expected to raise rates seven times in 2022.
The Fed also struck a hawkish tone by signaling a significant, rapid increase in its policy rate over the next two years – setting a goal to raise the Fed funds rate to 2.8% by 2023. In our view, it’s unclear whether the Fed will fully follow the projected rate path as it may come at a cost to economic growth and employment levels. While the Fed pivoted quickly to address persistently high inflation, policymakers need to be concerned about running an excessively tight policy. The latter approach may plunge the U.S. economy into recession, especially considering recent geopolitical risks. As a result, we believe that the Fed is likely to stay relatively cautious and act consistently with the goal to get inflation much closer to the target with minimal disruption to the labor market. Low levels of unemployment are necessary now as inflation this time is primarily driven by supply shocks and high commodities prices.
Developments in the Russia-Ukraine conflict also remained on investors’ radar. The war in Ukraine has triggered a spike in energy prices, with crude oil prices shooting up to 14-year highs on supply concerns. This has resulted in dampened growth and exacerbated inflation, especially in Europe. In addition to energy, Europe also imports some metals, chemicals, and agricultural products from Russia and Ukraine. While a recession in Europe is not our base case, we have reduced our European equities overweight as a tactical movement.
The most recent economic data has been mixed with U.S. markets proving more resilient in response to the Russian invasion. Eurozone data showed a decline in business activity, though the signals have not yet fully reflected the impact of the war. U.S. manufacturing conditions improved in February, with the ISM index rising to 58.6 from 57.6 in January, a touch better than expected. Payroll employment came roaring back in February as the Omicron wave continued to recede, and initial jobless claims set a 50-year record low. Consumer demand prospects are solid, with retail sales surging 4.9% in January, followed by a 0.3% increase in February. On the other hand, Eurozone business activity appeared to slow in March, as European companies’ costs soared with elevated commodity prices and supply chain delays due to the Ukraine conflict. The Eurozone PMI index fell to 57 in March from 58.2 in February.
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↓ Valuation | The S&P 500 posted a monthly gain of 3.7% with valuation for equity remaining negative. P/E: increased from 22.5 at the end of February to 23.3 at the end of March. Forward P/E: rose from 19.6 at the end of February to 20.1 at the end of March. Inflation-adjusted valuation metrics continued to be negative with inflation rising
↔ Sentiment | U.S. manufacturing conditions improved in February, with the ISM index rising to 58.6 from 57.6 in January, a touch better than expected. U.S. manufacturers benefited from solid demand, but supply-chain issues may not improve as quickly as expected, as indicated by increasing supplier deliveries. Consumer confidence fell for the third straight month to another cyclical low in March as gasoline prices rose and inflation and geopolitical risk remained in the headlines. University of Michigan consumer sentiment fell to 59.4 in March from 62.8 in February. Homebuilder confidence continued to decrease but was still well above the 50-point threshold. Despite limited supply that benefited short-term building conditions, rising construction costs pushed sentiment down this month.
↑ Technical | Technical indicators were positive as momentum indicators outweighed the VIX fear index. The S&P 500 was 1% above its 200-day moving average, 0.3% below the 100-day average, and 3% above the 50-day average. The VIX settled at 20.6 at the end of March compared with 30.2 at the end of February. Volatility spiked at the beginning of the month as investors assessed the risks of escalated Russia-Ukraine conflict and crude oil shot to 14-year record high. It was followed by a relief rally in the second half of the month with some clarity around the Fed policy and technical buying.
↑ Macroeconomic | The labor market remained tight, with payroll employment roaring back in February as the Omicron wave continued to recede. Initial jobless claims set a 50-year record low. Inflation remained elevated, with the CPI rising 0.8% in February following a 0.6% gain in Jan. On a year-ago basis, the headline and core CPI were up 7.9% and 6.4%, respectively. We expect inflationary pressure to linger for a while due to global supply-chain issues and rising energy prices. The PPI for final goods jumped 2.4% in February after increasing 1.5% in January. Consumer demand prospects are solid, with retail sales surging 4.9% in January, followed by a 0.3% increase in February. Personal income grew 0.5% in February, in line with expectations.
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As of 3/31/2022
1 Source: Bloomberg, NorthCoast Asset Management.
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