April saw a continuation of this year’s volatility. Last month, we wrote about the dramatic mid-March rally in stocks. That recovery, however, proved short-lived and did not continue into April. Shortly after the month began, the global stock market trended downward, and U.S. markets followed. Later in the month, after several days of positive or negative swings of over 2%, U.S. and global stocks had declined between 8% and 9%, pushing those stock markets back into correction territory for 2022. As we have written before, there’s nothing particularly unusual about a decline of 10%-15% in the stock market. Indeed, investors should expect such declines at least once per year. Still, this sort of volatility is not pleasant.
Less typical is the extraordinary pressure on long-term bonds. We moved our clients’ bond exposure away from long-term bonds some time ago, mostly because their yields didn’t justify the interest rate risk. Even after anticipating the possibility of this kind of trouble for long-term bonds, however, we have been surprised by the extent of their losses. As of April 30th, the Bloomberg US Aggregate Bond Index, for example, is down 9.5% year-to-date. But its possible relief is coming. Today, two-year U.S. Treasuries and ten-year U.S. Treasuries yield a similar amount. This suggests the market believes the Fed will not need to raise interest rates much higher to fight inflation (otherwise, investors would be demanding higher yields on new U.S. bonds). Such an outcome would be welcomed by fixed-income investors. Taming inflation without further pain from interest rate hikes, while finally receiving a moderate level of income from bonds, would be celebrated.
A cooling economy supports the idea that longer-term interest rates do not need to increase significantly from their current levels. A report on the U.S. first quarter GDP showed the economy slowed by an annualized real rate of -1.4%. The likely cause of the missing growth was large gains in inventory building. Last year, businesses front-loaded purchases which detracted from economic activity during the first quarter, at least how it is measured. Additionally, a surge of imports detracted another whopping 3.2% from GDP. Still, real consumer and business spending is very strong, even stronger than during the previous quarter. This robust spending could explain the stock market’s response to the report, a daily gain of 2.5%. Economists still see U.S. GDP growing at an annualized rate of 2%-3% for the remaining quarters of 2022.
Coinciding with this more subdued level of economic activity, the consensus market view is that inflation is already peaking. That would justify the belief that the Fed will not need to hike rates much to reign in surging prices. The merit of this view, however, will be tested in the coming months. Should inflation begin to moderate as expected while growth holds steady, it’s reasonable to believe interest rate increases will be moderate. On the other hand, should inflation not come down as expected even after interest rates are raised, the Fed may need to move more aggressively. As always, we continue to analyze market conditions to determine the appropriate portfolio positioning for our clients. If we can be of service, please let us know.