Tug of War

Sell in May and Go Away?

Investors buffeted by the ongoing correction in stocks and bonds could be forgiven for asking this question. The Fed’s aggressive half a percentage point increase in interest rates last week coupled with another report of elevated inflation earlier this week are serving to continue the turbulence investors have experienced so far this year. As the Fed fights inflation and corporate earnings growth is expected to slow, we have anticipated higher levels of volatility and, as the chart below shows, that is exactly what we have seen year-to-date.

Clearing the Bar

With all but the retailers now having reported first quarter earnings (many of these January fiscal year-end companies will report next week), we are encouraged by what has turned out to be yet another solid quarter of profit reports. While there have been several high-profile exceptions like Amazon, Netflix and General Electric, corporate America overall is navigating higher costs and a slower growth economy in encouraging fashion. Over half of reporting companies have delivered both sales and earnings above expectations, more than ten percentage points above the long-term average. While price action in response to these “beats” has been more muted amid high inflation and rising interest rates, a key observation we made at year-end remains in place – earnings estimates for 2022 continue to rise. We are prone to observe that what matters most for equity investors is earnings and what investors are willing to pay for a dollar of those earnings. For the factor over which companies have some degree of control, they have passed the test once again, supporting our ongoing overweight of large cap U.S. equities in client portfolios.

Peak Inflation

With earnings season winding down, the Fed and investors alike were closely attuned to this week’s latest inflation report. While the numbers came in two tenths of a percentage point above estimates, headline inflation of 8.3% in April likely marked the first of what we expect will be a series of disinflationary readings for the remainder of the year. Moderating gasoline and used car prices helped dull faster rates of inflation seen in housing (1/3 of the Consumer Price Index), airfares and groceries. Sequential core inflation (excluding food and energy) increased, but the “base effects” of rising year-ago prices should serve to moderate future numbers. As we discuss in this quarter’s investment video on the energy markets, while the war in Ukraine and newfound capital discipline by American oil producers could cause energy prices and inflation to remain higher for longer, new sources of production internationally and some degree of demand destruction amid $100 oil should preclude substantially higher prices. We will continue to keep a close eye on the progression of key inflation readings, but slower economic growth being facilitated by the Fed should help to keep inflation on a downward trajectory.

Reasons for Optimism

While inflation and Fed rate hikes continue to weigh on equity valuations, we are encouraged by the most recent movement of interest rates that the Fed does not directly control. After spiking to 3.2% on Monday, the benchmark 10-year U.S. Treasury yield has fallen to below the 3% level currently. While it is too soon to call a top in longer-term rates, the fact that they stopped going up this week is notable. At least for now, the bond market appears to be signaling confidence in the Fed’s ability to bring inflation under control, this at a time when an upwardly sloping yield curve supports our call that a recession any time soon is unlikely. As importantly, we would welcome the return of bonds’ ability to provide diversification benefits to equity-weighted portfolios, something that went missing in the first four months of this year as both stocks and bonds went down.

Takeaways for the Week:

• Stock market volatility remains elevated amid an ongoing correction

• While inflation remains high, we believe it will moderate in the months to come

Disclosure

The views expressed represent the opinion of Ferguson Wellman. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Statements of future expectations, estimates, projections and other forward-looking statements are based on available information and Ferguson Wellman’s views as of the time of these statements. Past performance may not be indicative of future results. Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational purposes only and not as a substitute for qualified counsel who can determine how this information applies to you. We believe the information provided is from reliable sources but should not be assumed accurate or complete.

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