What’s Driving the Recent Volatility? A Quick Guide
Like the candy, Sour Patch Kids, we have been experiencing a fair amount of sour in our markets. However, for investors, keeping an eye on the long-term goals of your portfolio while buckling down to trimming where needed and keeping debt under control in the short term will result in a balanced financial picture. There is still ‘sweet’ to come:
The Federal Reserve has been very clear about its intentions to move more aggressively in fighting inflation. It currently defines "more aggressively" as a likely series of 50 basis point rate hikes, beginning with the May Federal Open Market Committee meeting. This hike will mark the first time in 22 years that the Fed has doubled the standard 25 basis point increase.
In remarks at a panel discussion at the IMF on April 21st, Chairman Powell reiterated that “to be moving a little more quickly” on rate hikes is appropriate. However, he also indicated that he believes that financial markets are “acting appropriately generally,” meaning that they are adjusting to the expectations of higher rates.
Markets are forward-looking, so prices today reflect what markets think will happen in the future. An excellent example of this is mortgage rates: The average rate on a 30-year fixed-rate mortgage was 5.29% as the last week of April opened. In contrast, in early March, it was 3.76%.
Markets are having trouble interpreting this information. The problem is that we’ve heard the Fed’s intentions so far, but without corresponding data showing whether or not rate hikes are working, markets can’t assess the likely path. And that leads to volatility. However, volatility does not last forever.
Are We at Peak Inflation?
March inflation was 8.5% annualized, the highest in 40 years. It wasn’t surprising, but it’s still a complex number to digest. The discussion is about whether inflation at this level is something we'll have to live with for years or if it will subside relatively quickly, given Fed actions and a gradual resolution of supply issues.
One positive note: Core inflation, defined as all prices except food and energy, fell in March. Warmer weather will likely bring down energy costs as we enter late spring. Additionally, consumer and government pressure may result in lower prices at the pump as oil companies bring more drilling online.
Bond yields have increased significantly, and the dollar remains relatively strong as US growth continues to outpace other countries.
Why does this matter? Historically, the dollar appreciates at the start of Fed hiking cycles. And a stronger dollar means imports are less expensive, which could help offset inflationary pressures.
What About Growth?
The war in Ukraine has had an immediate and drastic impact on global growth. The IMF recently released a report on the world economic outlook that found lower growth likely.
The IMF is projecting that global growth will slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This projection is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January. Beyond 2023, global growth is forecast to decline to about 3.3% over the medium term. Again, US growth continues to outpace other countries.
What is Happening with Earnings?
We've discussed the macroeconomic situation. But what's happening on the ground with companies is equally important. After four record quarters of earnings results in 2021, investors are looking to the second-quarter earnings season for insight into where the markets are headed.
As of April 25th, approximately 20% of S&P 500 companies have reported first-quarter results. Of those, 76% have met or exceeded expectations on revenue and 82% on earnings. This week we will see approximately 50% of S&P 500 companies reporting, which will provide a better picture.
While revenue growth is likely to be strong, earnings per share expectations are moderating. This expectation means that margins may be stretched, and companies with pricing power will be in better shape to withstand ongoing inflationary pressures. In addition, a diversified approach continues to provide great benefits for investors.
How Should Investors React and What is The Bottom Line?
The increased volatility in markets and the lack of clear insight into so many variables may be unsettling. However, the overall message is that the economy's fundamentals remain strong.
Demand is strong for consumer goods, and better wages and more job opportunities lead more people to return to the labor markets. In addition, the Institute for Supply Management reports that inventories are increasing, which is a sign of resolving supply chain issues.
For investors, keeping an eye on the long-term goals, ‘the sweetness of your success’, of your portfolio, and keeping debt under control in the short term will result in a balanced financial picture.
We're definitely at an inflection point as the Fed increases rates more aggressively, and globally, governments react to the challenges of providing humanitarian assistance to Ukraine and keeping their economies afloat.
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