April was an awful month for investors with bonds and stocks both falling, resulting in one of the worst starts to a year in decades. Wall Street has moved from euphoria to fear over the last six months.
The S&P 500 index finished April -13.3 % YTD, Nasdaq -21.2% YTD, and IEFA, or iShares MSCI International index -13.17% YTD.
The much larger (by asset size and importance) bond market has been the real culprit of 2022. The 10-year Treasury note has surged from 1.5% to 3.0% this year, marking one of the worst bond routes in decades. As the Fed gets serious about taming inflation, prices of corporate and muni bonds have also tumbled. The iShares Aggregate Bond index -9.4% YTD, iShares's National Muni Bond Index -8.0% YTD.
Gold is up +4.5% along with oil and natural gas, both of which have led commodities higher.
Inflation was and always will be a monetary phenomenon. Money supply increased more than 40% over the past two years. Prices responded accordingly, whether in stocks or real estate. Bond rates were held down by federal Reserve buying up to 50% of the supply offered. The Fed balance sheet went from $850.8 billion in 2007 to $8.7 trillion in 2021.
It’s worth revisiting how the Fed arrived at this difficult position. The pandemic led to a recession in 2020. The government went on the offensive with money creation and inflation took hold. The Fed thought it would be transitory, but it was not so. 8% CPI prints scared the public and eventually the policy makers. Putin's invasion put the icing on the inflation cake as energy prices soared and steeled the Fed's resolve to begin a fight to bring it down. To turn back inflation it takes time and resolve. Having released the inflation Genie from her bottle, she does not easily or willingly return to confinement.
While the market is currently spooked by the Fed getting serious about reducing inflation, this change in policy is a positive. Two members of Crown’s Investment Committee started in this industry in the mid-1970s with high inflation, shortages, intermittent recessions, and compounded policy mistakes. It is not a scenario anyone wants to relive.
History tells us that markets always recover – if there is growth. The current earnings season has been strong with 80% of companies that have reported “beating expectations,” according to FactSet. Looking ahead, analysts expect earnings growth of 5.5% in Q2, 10.9% in Q3, and 10.9% in Q4 2022.
Prospects continue to be solid with many forecasters seeing $225-$230 for the S&P 500 companies in 2022. With the S&P 500 currently trading around 4,100, that gives us an 18.2x P/E ratio down from 21.4x on the Jan 4, 2022 peak. The five-year P/E average is 18.6, but the 10-year average P/E is 16.9.
In the coming months Wall Street will look for clarity with respect to inflation, monetary policy, and geopolitics:
- How high will rates go? Can the Fed engineer a soft landing?
- Will the Fed overreact and raise rates too much in the year ahead?
- Will Russia get more aggressive in Ukraine as Putin appears to be stalled in his advance?
- Will the West react well or poorly to nuclear threats?
- Will China, whose economy appears to be sinking, continue to back Putin?
The reading of AAII-Members shows 16.4% Bulls and 59.4 % Bears. This is the highest level of pessimism since March 2009. That month and year the stock market, as measured by the S&P 500, went to 666.79, a generational low.
As the Fed moves to raise rates and slow the creation of new money, the asset enhancement party is over. The Champagne has been spent and spilt and the hangover is upon us. This is what is required to reach a bottom in share prices.
Summer is near, and we hope you are looking forward to fun with friends and family!
All the best,
Doug Coppola - Executive Director & Investment Committee Chairman
Steve Lindgren - Chief Investment Officer & Partner
Bob LeBeau - Research Director & Investment Committee Executive