Cost pressures beginning to impact consumer behavior

Thoughts

• Equity markets fell for the second straight week, with an increasing number of investors viewing the recent market recovery as a “bear market rally” rather than a resumption of the bull market. This week continued the risk-off trend, with the S&P 500® Index losing 2%, and growth indexes seeing the greatest stress. Since the high on March 30, the index has lost 5% and is just 5% above the March 14 low. Rising interest rates and elevated commodity prices continue to pressure investor and consumer confidence while threatening to impact economic growth. The 10-year Treasury yield is at a three-year high at 2.86% and has increased by 1.35% this year.
• Investors have been nervous and skeptical for much of the year, though flows into equities had been strong, totaling $193 billion following the record $1 trillion last year. This resilience is showing signs of strain, with $16 billion of outflows in the most recent week, the largest in nearly four months. Flows into international funds are weak, with Europe losing for nine straight weeks, with year-to-date outflows of $22 billion. Despite higher interest rates, investor flows are not going to bond funds, as investment-grade and high-yield each lost over $4 billion last week. Investor sentiment continues to fall, with the AAII Sentiment Survey showing bears outnumbering bulls three-to-one, at 48% versus 16%. Bank of America’s Bull & Bear Indicator is at an “extreme bearish” reading and JPMorgan noted strong hedge fund selling over the past month.
• The market has shifted from a focus on externalities, such as the war in Ukraine and COVID-19, to fundamentals, but last week was a reminder that this shift to fundamentals is not bringing good short-term news. Rising inflationary pressures are stressing investor sentiment, consumer spending, corporate profits, and official Fed attitudes. While investor sentiment is low in anticipation of further deterioration in market conditions, investors should remember that fear tends to be overweighted in this environment. While we can expect continued volatility, we’re not anticipating sustained negativity in the market.

News

• Rising interest rates and commodities are beginning to impact consumer purchasing decisions. Retail sales rose a disappointing 0.5% in March, with 6.9% growth from a year ago compared with 18.2% in February. Adjusted for inflation, sales fell by 1.6%. Surging commodity prices are forcing consumers to pull back in other areas, with nearly 10% of all retail sales dedicated to gasoline. The housing market is becoming unattainable for an increasing number of potential buyers, with the payment on the median house up 35% from a year ago. This is causing a decline in mortgage purchase applications. Expectations for growth are moderating, with Goldman Sachs seeing a 35% chance of a recession in the next two years and estimates for first-quarter GDP growth at roughly 1%.
• Inflation continues to be a concern, with CPI at a 40-year high and PPI at a record high in March. Consumer price inflation on Tuesday was ahead of estimates at 8.5% and the highest reading since 1981. Gasoline and food were the primary drivers of the surge, though core CPI was elevated at 6.5%. There are concerns that inflation will begin to “crowd out” consumer spending given that real wages are negative, with a Bloomberg survey showing 84% plan to cut back on spending due to higher prices, with the biggest cuts in services and driving. Record high producer price inflation suggests that the pain is not over, as input cost pressure is often pushed through to consumers with price increases.
• Earning season accelerates this week, with 70 members of the S&P 500 reporting. The current estimate is for sales growth to be strong (+11%), while earnings growth slows (+6%). Growth is trending slightly above the expectations at the end of March, though the beat rates are below long-term averages, and the 5% growth would be the slowest rate in five quarters. Margin pressure from wage growth, commodity prices, and supply chain issues is evident, coming in below expectations and at the weakest level since the fourth quarter of 2020.

What to Watch

• Earnings will be the primary focus of investors this week, while economic data is light. Releases include housing starts on Tuesday, existing home sales and the Fed’s Beige Book on Wednesday, leading indicators on Thursday, and PMI data on Friday.