Market Memo
May 2022 – By Kyle Rohrwasser
The war in Ukraine continues as governments look toward a slowing global economy with continued inflationary pressures. News outlets have decreased their war coverage, but the conflict and its economic impact remain real. European countries have seen rising energy prices and COVID lockdowns in China have added to supply chain woes. In the United States, we feel these effects domestically through rising food and gas costs mainly. Based on the rising value of the dollar to other currencies, it implies that we are in better shape than most other economies.
Eyes have turned to the Federal Reserve in hopes that their efforts will be able to lower inflation while simultaneously maintaining positive economic growth. As expected, the Fed raised the target federal funds rate by 50 basis points and announced it would begin reducing its $9 trillion balance sheet in June. Federal Reserve Chair Jerome Powell put any mention of 75 basis point hike to bed, implying that they would not move too quickly. The market rejoiced at this news but quickly remembered the current economic backdrop and how rising rates negatively affect equity valuations. The strong employment number and job availability indicate that the Fed could move quicker if they wanted. The futures market is currently predicting a federal funds rate between 2.5%-3.0% by year-end, roughly 2% higher than its current 0.75%-1.0% rate.
We have seen the efficiency of trading within the market come to the forefront as all news is being priced in very quickly. The Federal Reserve announced their fed funds rate and balance sheet reduction intentions earlier this year, and the bond market traded to estimated year-end levels within a few months. With the intention of the Federal Reserve to slow down the economy to keep inflation in check, we have seen a dampened shift in both the bond market and equities as investors prepare for a recession.
Typically, when equities sell-off bonds tend to maintain their price and, in the past, have been used as dry powder to buy discounted equities. This time around we are seeing selling on both sides as shown in bond returns YTD this year compared to equities. The bond aggregate is off roughly 10% while the S&P is off 17.5% year to date.
Based on the market performance in April and May, it would seem corporate earnings have been missing estimates, but that is not the case. As of May 20th, 95% of the companies in the S&P 500 have reported actual results for Q1 2022. Of these companies, 77% have reported actual EPS (earnings per share) above estimates, which is right at the five-year average of 77%. With earnings increasing and stock prices declining, valuations have become more attractive and are close to pre-pandemic levels.
With Fed rate hikes through the summer, we continue to anticipate near-term volatility creating longer-term opportunities in the equity and fixed income markets as yields climb and equity valuations become more attractive. We continue to watch for opportunities and identify when shifts may be warranted. In the meantime, we are glad to discuss your questions and concerns.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.