The past few weeks have been volatile in the market, and amidst all the uncertainty it may be challenging to block out all the noise. The S&P 500 was down nearly 9% in April, and the Nasdaq down 13%, its worst month since October 2008, during the Global Financial Crisis.
Despite all the noise and volatility, it is not a time to panic, but rather the time to maintain a long-term growth oriented strategy.
Here’s What We Cover:
- Inflation
- The Federal Reserve’s Interest Rate Hikes
- Growth and Earnings in the US Economy
- Global Concerns
- The Real-Estate Market
Perhaps the greatest concern in U.S. households today surrounds inflation. March inflation was 8.5% annualized, the highest in 40 years. It wasn’t a surprise, but it’s still a difficult number to digest. The great Warren Buffet, Oracle of Omaha, shared his views on the state of the economy at the 2022 Berkshire Hathaway annual shareholders meeting, saying inflation swindles not just equity investors or bond investors, but even “the person who keeps their cash under their mattress.” In other words… we are all feeling the impact and stress of higher prices, especially in the food and energy sectors. For more of Buffett’s recent insights, click here.
Nonetheless, the news is not all negative, nor does the data mean a recession is certain. Here are some positives to remember:
- Near record-lows of household debt service payments as a percentage of disposable personal income
- Near record highs of real median household income
The Federal Reserve’s Movements
The Fed has been very clear about its intentions to move more aggressively in fighting inflation. It currently defines “more aggressively” as a likely series of 50 basis point rate hikes, beginning with the May Federal Open Market Committee meeting. This will mark the first time in 22 years that the Fed has doubled the normal 25 basis point increase.
In remarks at a panel discussion at the IMF on April 21st, Chairman Powell reiterated that it is appropriate “to be moving a little more quickly” on rate hikes. He also indicated he believes that financial markets are “acting appropriately generally,” meaning that they are adjusting to the expectations of higher rates.
Markets are forward-looking, so prices today reflect what markets think will happen in the future. A good example of this is mortgage rates: The average rate on a 30-year fixed-rate mortgage was 5.29% as the last week of April opened. For contrast, in early March, it was 3.76%.
Markets are having trouble interpreting this information. The problem is that so far, we’ve heard the Fed’s intentions, but without corresponding data showing whether or not rate hikes are working, markets can’t assess the likely path. And that leads to the volatility we are seeing today.
The discussion at this point is about whether inflation at this level is something we’ll have to live with for years or if it will subside relatively quickly, given Fed actions and a gradual resolution of supply issues.
Let’s look at the positives:
- Core inflation, which is defined as all prices except food and energy, fell in March.
- As we enter late spring, warmer weather will likely bring down energy costs.
- Consumer and government pressure may result in lower prices at the pump
- Bond yields have increased significantly
- The U.S. dollar remains relatively strong as US growth continues to outpace that of other countries.
- Employers have created more than 400,000 jobs for 11 straight months
Why does this matter? Historically, the dollar appreciates at the start of Fed hiking cycles. And a stronger dollar means imports are less expensive, which could help offset inflationary pressures.
Global Concerns
There are a number of global issues that are heavily weighing on the U.S. economy, largely the war in Ukraine and the strict lockdowns in China. The war in Ukraine has had an immediate and drastic impact on global growth, with looming uncertainty driving the market into choppy territory. In China, the recent lockdowns have triggered rising costs for companies and increasing inflation for U.S. consumers.
We can expect to see a slowdown in manufacturing-industry growth in the US as it is closely tied to China, though it will not be felt nearly as strongly here.
The International Money Fund (IMF) recently released a report on the world economic outlook that found slower growth would be likely. According to Charles Schwab’s own, Liz Ann Sonders, “a balanced view of growth in the first quarter is that consumption’s pace has slowed, business investment remains incredibly strong, and the fiscal drag persists.” To read a more in-depth analysis of growth and GDP, click here.
The IMF is projecting that global growth will slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. Beyond 2023, global growth is forecast to decline to about 3.3% over the medium term. This is to be expected as it was the robust boost from both fiscal and monetary policy during the pandemic that kept the economy afloat, which is now in a robust reversal. In tandem with the influx in inflation, we will see downward pressure on growth, incomes, and spending.
What is Happening with Earnings?
It is important not only to examine the macroeconomic situation, but delve into the micro-level. After four record quarters of earnings results in 2021, investors are looking to the second-quarter earnings season for insight into where the markets are headed.
As of April 25th, approximately 20% of S&P 500 companies have reported first-quarter results. Of those, 76% have met or exceeded expectations on revenue and 82% on earnings. The last week of the month will see approximately 50% of S&P 500 companies reporting, which will provide a better picture.
While revenue growth is likely to be strong, earnings per share expectations are moderating. This means that margins may be getting stretched – and companies with pricing power will be in better shape to withstand ongoing inflationary pressures.
How is it Impacting the Real-Estate Market?
The residential real estate market has been hot as rents and housing prices continue their upwards trend in the first quarter. According to Clear Capital’s Q1 Report, the median listing price for single-family homes nationally was 12.9% higher in February compared to last year. In metropolitan areas such as Miami and Austin, we are seeing rents continue to increase. For a more in-depth look at real estate today, check out Clear Capital’s report.
What does this all mean?
Usually, higher mortgage rates would mean an eventual cool-down of the housing market, but other forces are in play in 2022.
- Consumer and household balance sheets are in great shape (due largely to reduced spending, borrowing, and government stimulus)
- There are not enough single-family homes to match the current demand
- The influx of investors that have entered the single-family market present a newer source of housing demand
With all these factors, we anticipate housing prices will remain high and rent prices to increase. However, this does not mean other areas of real-estate will follow that trend. Multi-Family homes, self-storage, and hospitality sectors should fare well in the current inflationary conditions.
How Should Investors React?
The increased volatility in markets, along with the lack of clear insight into so many variables, may be unsettling. During these times, it would be prudent to focus on high-quality investments and utilize the ongoing instability to your advantage. Whether the market is up or down, the key is to invest in quality businesses with positive earnings, free cash flow, and low debt while remaining disciplined around rebalancing and diversification.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.