Rising rates and inflation continue to weigh on equities

Thoughts

• Equity markets continue to be under pressure, with the S&P 500® Index experiencing a five-week losing streak for the first time in 11 years. Volatility remains intense, with the last six trading days showing the two worst sessions since June 2020 and the best move since May 2020. Below the surface of the decline shows more damage, with over half of NASDAQ down more than 50% from their 52-week high. Weak investor sentiment is now clearly impacting flows, with equity funds and ETFs losing assets in four-straight weeks. Given the poor momentum, breadth, and investor confidence, volatility will likely continue until the fear subsidizes.
• Bonds continue to be positively correlated with equities, failing to provide the benefit of diversification, with the 10-year Treasury yield touching 3.20% on Monday, nearing the highest level since 2011. The yield on the Bloomberg US Aggregate Bond Index has reached 3.6%, while the high yield index has jumped to 7.4%, challenging the belief of investors that “there is no alternative” (TINA) to equities. Commodities have been the only major risk asset that has worked this year, with the S&P Goldman Sachs Commodity Index gaining 34%. The dollar continues to strengthen, gaining 8% this year, creating a headwind for earnings but will marginally help inflation.
• Market corrections are always stressful for investors, and the current one is teamed with the largest drawdown in bonds since the 1930s. Despite the fear and emotion driving today’s market, we are not seeing the same patterns of prolonged stress that we saw during the tech bubble and 2008 financial crisis. A much more likely scenario is a prolongation of our current cycle, which means now is a good time to buy rather than sell.

News

• The FOMC voted to raise the Fed Funds target rate by 0.50%, in line with expectations, while detailing the path of balance sheet reduction. Chair Powell noted that evidence suggests inflation may have peaked, and he believes a soft landing is possible given that households, businesses, and labor markets remain in good shape. Lost in the volatility in the equity market is similar weakness in the bond market. The Bloomberg US Aggregate Bond Index has lost more than 10% this year, which would be the worst year on record by a factor of three, with the previous worst year at -2.9% in 1994. Comments and actions by the Federal Reserve have convinced investors that the “Fed put” is no longer in play for the equity or bond market.
• Despite the volatile markets, the fundamental backdrop remains supportive, with better-than-expected job growth in April, strong PMIs, and encouraging durable goods orders and shipments. Inflation concerns remain intense ahead of this week’s reading on April consumer price inflation. The headline rate is expected to slow to 8.1% from 8.6% in March, while core CPI is forecast to drop to 6.1% from 6.5%. Pressure continues to come from supply chain constraints, commodity prices, and strong demand, though there is the belief that the peak has passed. This will represent the 14th-straight month with inflation above the Fed’s 2% target.
• Earnings season has largely passed, with 90% of the S&P 500 companies having reported. Growth is more than 9%, led by energy, materials, and industrials, with consumer discretionary and financials showing declines. Revenue growth of 13% was helped by strong pricing power, though input cost pressures resulted in tightening margins. Estimates for the full year continue to be modestly revised higher, now reflecting double-digit growth, compared with the 8% expected six months ago.

What to Watch

Inflation will dominate the headlines next week, with consumer price inflation set to be released Wednesday and produce price inflation slated for Thursday. Other notable releases include NFIB Small Business on Tuesday and consumer sentiment on Friday.