After a sharp recovery in March, markets resumed downside volatility in April as uncertainty remained high on a number of fronts. Most prominently, the Federal Reserve has started hiking interest rates in an effort to contain inflation. As we’ve discussed, this is a delicate task, as moving too aggressively can risk pushing the economy into recession, while going too light can fail in its objective. This is made all the more challenging by the fact that economic growth is slowing after its post-pandemic surge last year. When you include the ongoing war in Ukraine, with its commodity and geopolitical risks, and the COVID lockdowns in China, which have hampered supply chains, it is easy to understand why fear has been in the driver’s seat lately.
Despite these risks, it is not all doom and gloom, and there are a number of factors which advocate for confidently staying the course. First of all, as we near the end of the first quarter earnings season, 80% of companies in the S&P 500 beat their earnings estimates. While earnings growth is slowing, that earnings and margins are still holding up in the face of already high-cost pressures indicates some underlying resiliency. Next, there is growing evidence that inflation may be at or near its peak, which despite its concerning level, could ultimately help change the narrative if it occurs. Lastly, underlying economic growth is still strong despite its slowdown. The surprise decline in Q1 real GDP, for example, was mainly driven by a surge in imports as the dollar strengthened and a natural slowdown in inventory building as supply catches up with demand. Consumer spending, the bedrock and largest share of the economy, still grew at a rate of 2.7% after inflation last quarter.
This mix of positive and negative factors exists in market pricing as well. Many of the “safe-hiding” spots in recent months, such as commodities, materials, and defensive sectors like utilities and pharma, have become relatively more expensive, and may need continued bearish news to continue outperforming for an extended period. Likewise, higher growth pockets of the market, like Technology, are now materially cheaper as higher interest rates have pushed down their multiples and priced in slower growth. To the extent secular growth trends remain intact, it could represent a long-term buying opportunity despite continued near-term headwinds. Fear gauges are also at high levels, which statistically often leads to a relief rally upon a slightly positive shift in narrative. We already saw a little bit of this last week when the market initially rallied after the Fed took a 75 basis-point hike off the table before giving up those gains
These reasons are why we believe maintaining a balanced and sector diversified approach is best, as there are plausible scenarios that could cause big relative moves in a variety of directions. The fact that the expert economists at the Federal Reserve are now playing “catch up” just goes to show how truly difficult predicting the path of data can be. This is why we take a long-term focus in investing.
Volatility will likely continue for some time as the market continually reassesses the impact of Fed hikes on growth and the evolution of supply chain and commodity shocks coming out of Europe and Asia. The stickiness of this inflation and whether consumers start tightening their belts more remains to be seen. But at the same time, much of the “hot air” has been taken out of the market already by the recent selloff, and many areas now seem to offer decent value for a long-term horizon. You can be confident that we are evaluating such opportunities to add value in portfolios, while at the same time always seeking to maintain the appropriate balance necessary to weather the storm.
We welcome your question and comments and wish you and your families well. Thank you for watching.