At the close of business last Friday, global equities were lower on the week amid multi-percentage point intraday swings. Rising rates and higher oil prices contributed to the volatile market backdrop. The yield on the US 10-year Treasury note rose to 3.11%, the highest level since 2018, from 2.90% last week. The price of a barrel of West Texas Intermediate crude oil rose $3.30 to $109.90. Volatility, as measured by the Cboe Volatility Index (VIX), rose to 33.1 from 30 a week ago.
SPECIAL NOTE: We are recommending further adjustments to your portfolio. Please contact Glen at 604.992.6638 or Mike at 604.291.9200.
It never feels good to invest while the market is chaotic, but very often those periods end up being the best opportunities. 2022 saw the Nasdaq record its worst monthly performance since November 2008 and its worst start since 2001. The S&P500 had its worst months since March 2020. Bearish sentiment hit 59.4%, the highest level since March 5th, 2009. The US dollar broke out to twenty-year highs driven by yen weakness.
The markets have been hit with a series of issues starting in February 2020 with the outbreak of the COVID-19 pandemic followed by supply chain disruptions, The Ukraine conflict, slowing growth, and the fear of increasing interest rates to combat inflation. The market’s divergence between its price performance, and positive company commentaries about strength in the business despite the headwinds of supply chains, and war in Europe, is the greatest I’ve seen in my career. April 2022 was one of only four months since 1973 where the S&P500 returns are down greater than 5% and bonds have lost over 2%. The other months this occurred were in 1983 and 2008. Despite optimism from most of the CEOs on earnings calls, the market is clearly at maximum pessimism surrounding the Federal Reserve and inflation. There was a great article in this weekend’s Financial Post by Peter Hodson which I encourage you to read. It is titled “The Upside Down Market, Where Strange Things Happen.”
Before the Global Financial Crisis, 55-60% of a stock’s movement was because of idiosyncratic factors. That fell to 30-35% during QE2 in the 2012-2014 period. Normality began to return in 2017 to March 2020 when roughly 50% of what was driving stocks was idiosyncratic. Post-COVID, less than 20% of a stock’s movement is based on its fundamentals and the other 80% is driven solely by macroeconomic factors. Imagine trying to figure out why two growth stocks, an athletic clothing company, and a diabetes device company, are both down 8% on the same day with no news. It’s because they are both in a “growth” trading basket (an ETF) and they have become correlated to each other. This is what has made this market so frustrating year to date—stocks aren’t trading on company fundamentals.
This current frustration is leading us to long-term optimism. The first reason is that it appears that QE (Quantitative Easing) is responsible for some of these macro correlated trades, and the years that macro influence fell overlap with the end of QE. QE ended in March and QT (Quantitative Tightening) has begun. Differentiation within the growth stock universe should begin as QE fades and earnings season winds down.
The second reason has to do with the valuation of growth stocks today. The relative valuation of growth stocks is now at the lowest level since 1980, and lower than in 2002 and 2016. We are heading into a period of lower economic growth which bodes well for companies with secular growth tailwinds. We don’t believe we are headed for a recession. Looking out over the next 5 years, we really love this setup.
Consumer sentiment is approaching the lows seen during the financial crisis of 2008. A similar indicator, the Fear and Greed index, is edging on Extreme Fear. Consumer sentiment tends to be a contrarian indicator, and negative sentiment like this rarely stays for an extended period. Historically, the subsequent 12-month returns from the bottoms of market sentiment have been favourable to markets with extremely negative sentiment.
We are likely very close to peak year-over-year inflation. This is important because while stocks have typically struggled when inflation is rising, markets act significantly better after inflation peaks. In the ten instances where the index rose the year following a substantial inflation spike, the total return for the S&P 500 jumped by an average of 22% over the subsequent year.
I cannot predict the low or the bottom, but if current market trading analogies are 2001, 2008, and 1973, we’ve priced in a lot. I am very happy with the continued growth and fundamentals of the companies in your portfolio. With stronger earnings and revenues in the face of stock price declines, many companies in your portfolio remain exceptionally attractive. We believe Canada will be one of the best places to be invested in for the next couple of years. Your fund managers are being offensive in buying great companies at significant discounts. It is clearly a stock pickers market.
CANADIAN ECONOMIC NEWS
Our economy added 15,300 jobs in April, the third monthly increase in a row. This was enough to push the jobless rate down to a record low of 5.2 percent. Alberta had the most job gains. We have experienced an unseasonably cold start to the year and as a result, construction and retail trade employment were weak. We have also seen a spike in Covid cases where one in ten workers had to take time off from their jobs.
US ECONOMIC NEWS
With about 87% of the constituents of the S&P 500 Index having reported for Q1 2022, blended earnings per share show that earnings growth is running at 8.6% while sales rose about 13.4% compared with the same quarter a year ago. Only the energy sector is measurably beating analysts’ earnings estimates.
Fed steps up tightening pace
As widely expected, the US Federal Reserve hiked its federal funds’ target rate 50 basis points to between 0.75% and 1% on Wednesday, the first half-point hike since 2000. It was also the first time in two decades that the Fed hiked rates at consecutive meetings. Markets took temporary comfort in the news that policymakers are not actively considering larger hikes in an effort to bring rates quickly toward neutral. However, Fed Chair Jerome Powell took the unusual step of suggesting that the FOMC will hike rates an additional 50 basis points at both the June and July meetings. Powell was unexpectedly optimistic regarding the prospects for an economic soft landing.
EUROPEAN ECONOMIC NEWS
EU near agreement on Russian energy ban
The European Union is reportedly close to an agreement that would phase out imports of Russian oil over the next six months and natural gas by the end of the year. Several smaller EU member states that rely heavily on Russian energy supplies are seeking exemptions from the pact. Germany, the bloc’s largest economy, announced this week that it was ready to move forward with the ban even as the country’s economy minister said they should prepare EU consumers for big economic impacts and higher energy prices because of these actions. The energy phaseout is part of the sixth round of sanctions against Moscow. The exclusion of several more Russian banks from the SWIFT interbank messaging system is also contemplated. US crude oil exports to the EU surged to nearly 50 million barrels in April, the most since 2016.
JAPAN, CHINA, and EMERGING MARKETS ECONOMIC NEWS
Lockdowns hit China’s economy
Economic activity slowed sharply in April as China struggled to contain the spread of COVID-19. Lockdowns in some areas and more far-reaching mobility restrictions in others saw output drops in both the manufacturing and services sectors last month. Curbs on in-person services helped send the services-sector purchasing managers index sharply lower to 41.9, down from the 48.4 reading in March, while the manufacturing index slumped to 47.4 from 48.4. Late this week, President Xi Jinping underlined the government’s commitment to its zero-COVID policy, warning against any slackening in mitigation efforts, despite increasing social discontent.
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