Stocks remained volatile during the last week of April. The S&P 500 Index produced a -8.8% total return during April, and smaller cap stocks performed even worse, as the Russell 2000 Index declined by nearly 10%. Nearly all growth sectors declined by double digits for the month as interest rates moved higher. For the first time in a while, international equities outperformed the US as large-developed international equities declined by more than 6.5% for the month. Even bonds declined in April with the Bloomberg Bond U.S. Aggregate Index declining by -3.8%. To be blunt, April was an ugly month! It was so ugly that the last day of April trading was the worst last day of the month decline since 1998.
We have mentioned our belief the market has been “priced to perfection” and we are seeing the effects of this. The market is punishing stocks for negative news, and any hint of a slowdown in growth or earnings has led to significant selling pressure. This is especially true for the technology sector.
As we enter May, the markets are facing four main headwinds: (i) the hawkish Federal Reserve, (ii) rising inflation, (iii) the geopolitical and global growth risks from the Russia/Ukraine war and, (iv) global growth risks from China’s “Zero COVID” policy and lockdowns. There is always uncertainly for investors to account for, but the current level of certainly is heightened.
Federal Reserve policy remains the driving force as the central bank raises interest rates and shrinks its balance sheet to ease inflation pressures. This is a difficult and delicate balancing act, as the Fed has never had to implement such a strategy. Low interest rates and bond purchases stabilized the U.S. economy during the Covid pandemic but removing the two pandemic-era monetary stimulus policies is proving to be enormously disruptive.
Interest rates rose again during April as the 10-year U.S. Treasury yield surged 0.57% to 2.89%. Interest rates represent the cost of money and are used as an input to value company shares. A higher Treasury yield offers investors a higher rate of return. To incentivize investors to own riskier assets, such as stocks, the expected return must increase. Buying an asset, such as a house or stock, at a lower valuation should increase the expected return, which means the theoretical value of the asset should be lower as rates rise. Conceptually, this is a changing process that the market is currently working through – trying to find the appropriate “theoretical fair value” of a company’s shares as interest rates rise. This is in addition to dealing with geopolitical tensions, new Covid lockdowns in China, and surging inflation.
What Can We Expect Moving Forward?
There is no easy answer or definitive path forward. This year’s selloff indicates some degree of tighter Federal Reserve policy is already priced into the market – we just do not know how much. In addition, the list of market uncertainties remains long, including corporate earnings quality, economic strength, and the path of Federal Reserve interest rate hikes. Until the market receives clarity on these uncertainties, volatility is likely to remain elevated. The bumpy ride may not be done yet.
As always, please contact us with any questions,
Dennis P. Barba, Jr.
President & Managing Partner
Michael P. Finkelstein, CFA
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the authors and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request. CAR-0522-00153