Stew’s Views: April 11, 2022
April 11, 2022
Three Things to Watch This Week
As we look ahead to this holiday week of Easter and Passover, there is no shortage of events over the coming days to keep investors and savers alert. Volatility across all asset classes has become a hallmark of 2022, as both knowns (central bank rate hikes) and unknowns (Russia/Ukraine) have created what seems like a pendulum — as equities and credit spreads zig zag, as rates march higher. Looking at the short holiday week, there are a few events that have the potential to create more volatility in the financial markets:
US CPI (Tuesday, April 12)
It’s interesting to see how the market’s attention gravitates to the economic number releases “of the moment.”
In the 1980s, trading floors anxiously awaited the US trade report that showed last month’s imports/exports, as trade was the economic and political lynchpin of the day. That morphed into the Thursday afternoon Money Supply release from the Federal Reserve in the late 80s and 90s, as all things related to monetary base were driving investors’ attention. Over the past two decades, the first Friday of the month morning release of the Employment Report, with Non-Farm Payroll and Unemployment Rate, took top billing.
At present, it’s a safe bet that monthly inflation numbers will take top billing, as the Fed has put their dual mandate to rest for the time being to focus on one variable—price stability. This week’s CPI report will be watched closely. Even one of the Federal Reserve’s most dovishly perceived governors, Lael Brainard, recently threw her hat into the ring, quoting Paul Volker and arguing for both aggressive Fed rate hikes and balance sheet reduction to stem the rise of inflation. It’s not clear to many that supply side inflation (supply chain disruptions, commodity shortages etc.) can be stymied by monetary policy, but the Fed has made their intention clear. The US Consumer Price Index has steadily risen from .12% in May 2020 to 7.9% currently, and this week’s release is forecasted to have an 8 in front of it (8.4%)! Ahead of the May FOMC meeting, investors will be watching the release closely—see the CPI chart below:
This week marks the beginning of quarterly earnings releases in the US, with the major banks kicking off with their results from the prior quarter in the latter part of the week. In addition to typically bringing in waves of corporate bond issuance as the financial institutions come out of the quiet period, earnings have taken on paramount importance as inflation has moved higher, and the Fed is doing their best to tighten financial conditions.
With the current P/E ratio of the S&P 500 at close to 21, it’s difficult to see much multiple expansion from these lofty levels in an environment of Federal Reserve rate rises, balance sheet reduction and meaningful inflationary pressures. Thus, those looking for continued rallies in the equity market are banking on the denominator in the P/E ratio to continue to improve.
The S&P 500 and the growth of the Federal Reserve’s balance sheet look like they are moving to the beat of the same drummer. As the balance sheet starts to shrink in the coming months, earnings momentum will have to continue to expand at a decent clip to keep the positive momentum in stock prices in place. See chart below:
High Yield’s April Showers?
We advocated adding high yield fixed income exposure a few weeks ago, and since then, high yield index spreads as measured by Bloomberg’s HY Index have contracted from +400 to +310. The fundamental credit backdrop remains strong, with cash on balance sheet, low corporate leverage, and bond holder friendly corporate actions.
In an environment as volatile as the one we are living in 2022, taking some chips off the table to re-engage in any spread widening has merit. It should be noted, however, that in addition to all the positives for high yield credits, there is also an incredibly good season—for the past 15 years, the high yield market has had positive returns in the month of April. Maybe the first week of the month’s showers will bring high yield’s usual flowers in the coming weeks? See chart below: