Weak investor sentiment drives “risk-off” approach

Thoughts

• Investors continue to aggressively shift to risk-off postures, with the S&P 500® Index trying to avoid a four-week losing streak. A late-week selloff saw the S&P 500 lose over 4% in two sessions, bringing the Index to within 2% of the March low. Investors are seeking quality, with a rally in Treasuries and weakness in commodities and crypto. Investor fears this year have shifted from the Omicron variant to the Fed and inflation to Russia/Ukraine, and now to the lockdowns in China, as the lockdown in Shanghai enters the fourth week.
• Weak investor sentiment has begun to drive negative equity flows, with equity funds experiencing their worst outflows since the early days of the pandemic, losing $35 billion in two weeks. Goldman Sachs data shows hedge fund positioning at 52-week lows, while the surge in the put/call ratio reflects the desire for greater protection. The AAII recently fell to a 30-year low, and the Bank of America Bull & Bear indicator has fallen to a contrarian “buy” signal. Extremes in sentiment and flows have historically been seen at inflection points for the market, as extremes often lead to market reversals.
• Though we’ve seen weak sentiment for the first several months of 2022, we’re now seeing weak equity flows, which is a notable but likely a short-term challenge. In this environment, investors should pay attention to the fundamentals, which are showing resilience. Negative sentiment is carrying us into earnings, where we’ve seen companies that beat expectations not enjoy a stock bump. However, we expect to see companies buy back their stock after reporting earnings, which will be a net positive for the market overall.

News

• Earnings season is set to accelerate, with roughly one-third of S&P 500 companies set to report earnings this week. To date, 20% of the S&P 500 companies have reported, led by financials, consumer staples, and industrials. Growth is trending towards 7%, a modest beat from the 5% expected at the beginning of the quarter, though margins are contracting with 11% revenue growth. A high percentage of companies (80%) are reporting numbers above estimates, though they are beating by a below average 9%. Also, just 56% of companies are seeing positive price movement following the beat, suggesting they were priced in. Common themes in management commentary are a solid macro backdrop and a pickup in spending on services, offset by input cost pressures and a strengthening dollar.
• Fed Chair Powell hinted that a 0.50% hike may come at the May meeting, saying, “We’re going to be raising rates and getting expeditiously to levels that are more neutral, and then that are actually tightening policy if that turns out to be appropriate, once we get there.” The most recent dot plot shows a terminal rate of 2.0-2.5%, which may not be sufficient this cycle, with the 2-year yield touching 2.80% on Friday. The core PCE deflator (the Fed’s preferred inflation metric) will be released this Friday, with a reading of 5.3% expected versus a year ago. The curve currently embeds an 83% chance of seven or more hikes through July, which would require two 0.50% hikes and one at 0.75%. European investors are beginning to price in 0.80% of hikes for the ECB this year, with a potential to end bond buying in July.
• Global geopolitical tension remains high, with reports that Russian President Putin is no longer interested in a ceasefire in Ukraine, and instead is focused on gaining ground. The U.S. aims to degrade Russia’s military capability with the announcement of additional military aid to the country. French President Macron defeated challenger Le Pen by a wider than expected margin, calming markets. China is seeing a continued spread of coronavirus in Beijing, with many wondering if the “zero Covid” policy will lead to a shutdown like what is seen in Shanghai. The People’s Bank of China cut its required reserve requirement for banks by 1% to stimulate growth given recent lockdowns. The dollar index has surged to the strongest level since just after the 2016 election, pressuring domestic earnings and multinational competitiveness.

What to Watch

• Housing data will be in focus this week, along with a substantial acceleration in earnings releases. Other data include consumer confidence on Tuesday, revised GDP on Thursday, core PCE deflator, personal income and spending, and consumer sentiment on Friday.