April 2022 Market Commentary
May 9, 2022
April showers bring May flowers. Not exactly a market saying, but after this past April, investors would be happy for the proverbial skies to part and reveal a little sunshine. Buffeted by a number of cross currents- inflation, interest rates, the Fed, economic data, ongoing fighting in Ukraine, and Chinese lockdowns- equity markets (S&P 500) experienced their worst month since March 2020, and capped their worst fourth-month stretch to start a year since 1939.
For the month, large caps (S&P 500) fell 8.8%, ending in correction territory, down 13.9% from their record high in early January. The tech-heavy NASDAQ fell 13.3%, its worst month since October 2008, to end in bear market territory, down 23.2% from its record high in mid-November. Small caps (Russell 2000) fell 10.0%. International markets also faced selling pressure during the month, with developed (MSCI EAFE) and emerging (MSCI EM) markets falling 6.8% and 5.8%, respectively.
The Federal Reserve’s increasingly hawkish stance on monetary policy was arguably the largest headwind to the markets. Early in the month, Fed Vice-Chair Lael Brainard, often viewed as more “dovish”, indicated that the Fed will begin reducing its balance sheet at a “rapid pace” starting as soon as May. Shortly thereafter, the release of the Fed’s March meeting minutes indicated that the central bank expects to begin reducing its balance sheet by $95B/month beginning in May. Towards the end of the month, Fed Chair Jay Powell stated that it is “essential” for the Fed to restore price stability, but that orchestrating a soft landing- raising rates without triggering a recession- will be “challenging”. On the topic of future rate hikes, Powell said it would be “appropriate in my view to be moving a little more quickly”, before going on to say that a 0.50% increase will be “on the table” for the May meeting. The combined effect of the Fed’s evolving commentary was to raise interest rates across the curve; the 2-Year Treasury yield increased over the course of April from 2.33% to 2.71%, while the 10-Year Treasury yield increased from 2.33% to 2.93%. The increase in yields and the growing belief that the Fed may become even more aggressive in fighting inflation contributed to increased equity market volatility and selling pressure.
Inflation continued to move higher as the consumer price index (CPI) rose 1.2% in March alone. Compared to a year earlier, CPI inflation jumped 8.5%, the fastest pace since 1980. Prior to Russia’s invasion of Ukraine, it was widely expected that inflation would begin to decelerate in 2Q22 as the large increases in inflation that began in 2Q21 were lapped. However, the onset of fighting in Ukraine has put renewed upward pressure on global inflation.
Collectively and individually, Russia and Ukraine are major exporters of agricultural, energy, and other commodities. The disruption of those exports is being felt in a number of different ways. One recent example is the decision by Indonesia, the world’s largest palm oil exporter, to ban palm oil exports in an effort to protect the country from rising inflation and ensure enough domestic supply. The announcement was precipitated by soaring global vegetable oil prices, which have risen ~50% over the past six months, due in part to the disruption of Ukrainian sunflower seed oil exports, which account for ~50% of global supply. As Ukrainian exports have dwindled, consumers have turned to other substitutes, including palm oil, driving prices for all vegetable oils higher. Indonesia’s ban will exacerbate already soaring food prices, placing additional upward pressure on global inflation and increasing the number of people faced with food insecurity. That in turn could give rise to increased political instability, particularly in those countries where governments subsidize food costs but are finding it increasingly difficult to do so in the face of rising prices.
US economic data released during the month pointed to slowing economic growth as evidenced by 1Q22 GDP, which contracted at an annualized pace of 1.4%. The decline was driven by reduced government spending, net exports, and inventory drawdowns. Importantly, the main engine of economic growth, consumer spending, was positive, increasing 2.7%, along with business spending which rose 2.3%. Consumer spending on goods fell slightly, while spending on services accelerated, likely reflecting the continued normalization of spending patterns as Covid cases wane and related restrictions are loosened. Employment remained a bright spot, with the March employment report showing the economy added another 431K jobs during the month. That marked the 11th consecutive month in which the economy added 400K+ jobs.
Fixed income returns were negative for the month, pressured by ongoing concerns about rising inflation and interest rates. The Bloomberg US Aggregate Bond index, the broadest measure of the US bond market, fell 3.8%, its 5th consecutive monthly loss, and longest such streak since 1994. Longer-dated bonds, which are more interest rates sensitive, were hit particularly hard with the 30-Year Treasury falling 9.8%. No sector was immune to the selling pressure as corporates, high yield, and munis were all negative, falling 5.0%, 3.6%, and 3.0%, respectively.
The current period continues to be one of the more volatile ones for fixed income in recent history. As measured by the MOVE index, a weighted average of volatilities on the 2-, 5-, 10- and 30-year Treasury, the past couple of months have been the most volatile period over the last 17 years, with the exception of a couple weeks at start of the Coronavirus pandemic and the Great Financial Crisis. While the concern in March was a flattening curve and its potential implications, April saw the curve steepen, alleviating some recession fears. The 10-year Treasury rose 60 basis points (0.60%) on the month, while the 2-year Treasury increased 38 basis points. Both hit new recent highs, last seen in December 2018. The volatility continues to stem from high inflation on one hand, and concerns about slowing growth on the other. Continuing high inflation has led to a very hawkish Federal Reserve, with the market now pricing in over 250 basis points of hikes through the remainder of 2022, as well as an acceleration of the balance sheet reduction plan, which should begin soon after the next Fed meeting in early May. Concerns about slowing growth have been led by new outbreaks of COVID-19 and ensuing lockdowns in major Chinese cities. Market volatility continues to reflect the confluence of those two factors, with investors trying to determine the appropriate level of interest rates that will slow inflation while maintaining economic growth.
Municipal yields continued to track Treasury yields higher, reaching new highs last seen at the onset of COVID-19 in March 2020. Two-year muni bonds yields increased 44 basis points in April, while the 10-year muni increased just under 50. Municipal yields continue to look very attractive on a relative basis to Treasury bonds, with yields nearly equal, even before accounting for the tax benefit.