Has Investor Sentiment Turned Too Negative?
Stock prices continue to face pressure from rising interest rates, near record-high inflation, and most recently, growing fears that the U.S. economy is headed for a material slowdown. Real estate, financials, technology, and consumer discretionary lost more than 3.0% last week. Consumer staples was the only S&P 500 sector to finish the week higher. In addition, the 10-year U.S. Treasury yield took a break from its tear higher, ending the week at 2.93%. West Texas Intermediate crude finished at $110.38 per barrel, and Gold closed at $1,808.40 per ounce. During the week, Bitcoin fell below $26,000, its lowest level since December 2020, and as the digital asset trades more akin to a high-risk growth stock than an inflation hedge.
Last Week’s CPI Report Did Little to Calm Investors’ Nerves
Unfortunately, last week’s consumer and producer inflation reports did little to change the market’s negative tone. Headline April CPI came in at +8.3% year over year (y/y), cooler than the +8.5% record pace recorded in March but hotter than the +8.1% expected. Additionally, core CPI inflation (ex. food and energy) rose +0.6% month over month (m/m) in April, twice as much as the rate in March and hotter than the +0.4% expected. On the producer side, prices in April showed signs of moderation yet remained at very elevated levels.
Notably, while consumer and producer prices are likely peaking in the U.S. (a longer-term positive for growth), the evidence of the peak may not look linear over the coming months. In our view, the year-over-year headline and core inflation rates should moderate as we move through the year. Still, investors should expect the data to look more mixed by segment, with the pace of moderation not equal in all areas measured within the Consumer Price Index (CPI) and Producer Price Index (PPI).
Bottom line: Inflation data may look messy for a period, with prices remaining elevated in some areas (ex., services, food, and energy), while the pace of price gains moderate in other areas (ex. goods). Further, additional reports measuring wage inflation are likely to influence investors over the coming months, as labor costs (inside a tight job market) play a significant role in determining the corporate outlook and impact on profit margins.
Last Thursday, Fed Chair Jerome Powell said the Federal Reserve couldn’t guarantee a soft landing. Mr. Powell noted that entrenched inflation at such high levels would be the worst scenario for the economy. The Chair added it would be “quite challenging” for the Fed to engineer a soft landing in the process, considering some dynamics (e.g., supply chain disruptions) are out of its control. As a result, investors are becoming more concerned that in the Fed’s desire to curb inflation pressures and aggressively raise interest rates, the central bank could overtighten policy and risk sending the economy into a recession. By Friday, Fed fund futures had begun to dial back some of the most aggressive assumptions for rate hikes this year, recognizing that if more significant headwinds for the U.S. economy develop in the back half of the year, the Fed may be forced to slow rate hikes.
The S&P 500 Down More than 15% Since the Start of the Year as Investors Face Multiple Headwinds
From a stock perspective, the S&P 500 finished last week roughly 16.5% lower than its January high. Though the broad-based U.S. stock benchmark has thus far avoided falling into a bear market (defined as a 20% or more decline from a recent high), several broad indices have already felt the bear's wrath. The NASDAQ and Russell 2000 Index are each off their all-time highs by more than 27%. Communication Services, Consumer Discretionary, and Information Technology also sit firmly in a bear market today. It’s also worth mentioning that many stocks within the S&P 500 are down 20% or more from their highs, so while the broader average has avoided a bear market so far, that’s certainly not been the case for many of its constituents. Equity prices have spent most of this year resetting to the realities of higher rates, elevated inflation, and slowing growth.
With that said, the market may need to see more capitulation, which could send stocks even lower over the very near term. Fed-tightening, persistent inflation, China COVID-19 lockdowns, the Ukraine war, and a global growth slowdown are ongoing stock headwinds. With investor sentiment at some of its weakest levels in decades and traders moving from a “buy-the-dip” strategy to “sell-the-rip,” longer-term investors should expect a volatile environment ahead. In such environments, stocks can overcorrect to the downside, similar to how they overshot to the upside after hitting the pandemic lows in March 2020.
Long-term Buying Opportunities Being Created as Several Parts of the Market May Be Oversold
However, more areas of the market are becoming extremely oversold today. Sentiment is likely too pessimistic given the still strong corporate backdrop. Expectations for Fed-tightening look too aggressive, in our view. Shanghai and Beijing won’t stay locked down forever. And the Ukraine war appears contained, while global growth should remain positive in 2022. At some point, stock prices will bottom, and investors will be able to envision an environment where equities may rise in the future. We believe long-term buying opportunities are being created every day, and the further stocks sink. Investors should be putting their shopping lists together now and mapping out a strategy to act. Your Ameriprise advisor is here to help in this department.
Looking ahead to this week, the economic calendar shifts from inflation to growth. April retail sales will be a notable highlight, as sales are expected to increase over March levels. However, gasoline sales and the continued unwinding of stimulus/child tax credit spending could provide some spin on the ball when deciphering consumer readthroughs. A batch of April home data, including building permits, housing starts, and existing home sales, should provide additional insight into consumer reactions to higher interest rates. According to the St. Louis Federal Reserve, the median sales price of a new single-family home stood at $436,700 at the end of March. Interestingly, a 30-year fixed-rate conventional mortgage for that new home costs roughly $670 a month more today than one year ago.
In addition, the Q1 earnings season essentially comes to a close this week, with 15 S&P 500 companies reporting results, including several big-box retailers. With roughly 91% of S&P 500 Q1’22 earnings reports complete, the blended earnings per share (EPS) growth rate is higher by +9.1% y/y on sales growth of +13.4%. Although a record number of companies cited the term “inflation” on their earnings calls, Q1 profits came in well ahead of analyst estimates, indicating customers were willing to absorb higher prices. But will that still be the case when the Q2 earnings season rolls around in July?
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