Last Week In Review
“Wash, rinse, and repeat” seems to be the theme of equities right now. Most of the major benchmarks endured a fifth consecutive week of losses as interest rate and inflation worries weighed on sentiment, especially toward growth stocks. Last week’s losses briefly pushed the Dow Jones Industrial Average into correction territory, down more than 10% from its recent highs, where it joined the S&P 500 and S&P MidCap 400 indexes. The Nasdaq Composite and the small-cap Russell 2000 Index ended the week firmly in bear markets, down more than 25%.
Markets were especially volatile late in the week, although the CBOE Volatility Index (VIX) remained slightly below the intraday levels briefly reached in late January. Traders I spoke with noted that the market did not have difficulty with what were expected to be record flows of exchange-traded funds as investors unwound leveraged positions.
Wall Street had been bracing for a week of volatility given the Federal Reserve’s highly-anticipated policy meeting on Tuesday and Wednesday and several critical economic data releases. On Wednesday afternoon, Fed policymakers announced a 50-basis-point (0.50 percentage point) increase in the federal fund’s target rate, the largest since 2000, to 0.75% to 1.00%. Officials also announced that the Fed would begin allowing its holdings of Treasuries and agency mortgage-backed securities to decline in June at an initial combined monthly pace of USD 47.5 billion, stepping up over three months to USD 95 billion.
The market’s initial reaction was muted, as the moves were mainly in line with expectations. However, at his post-meeting press conference, Fed Chair Jerome Powell surprised many by stating that a hike of 75 basis points (0.75 percentage points) was “not something we are actively considering.” With his assurances that a recession was unlikely in the near term, his comments were generally perceived as more dovish than anticipated. As longer-term bond yields decreased, bond prices rose, and equity benchmarks rallied sharply in late Wednesday trading.
US – Markets & Economy
However, the market’s gains more than unwound last Thursday, as investors appeared to reconsider whether a 75-basis-point increase was off the table—and would be confirmed as an ongoing possibility by other Fed officials scheduled to speak the next day. Some potentially problematic inflation data probably reinforced such concerns. The Commerce Department reported that nonfarm unit labor costs jumped 11.6% in the first quarter, well above elevated consensus forecasts of around 9.9%. The increase was primarily due to a 7.5% drop in productivity, the most significant quarterly decrease in nearly 75 years. While many economists cautioned that the figure was complicated by the surprise 1.4% annualized decline in the first-quarter gross domestic product (GDP), which was further complicated by a record trade deficit, it was still a more significant drop than most had anticipated.
Wall Street also appeared to react negatively to Friday’s closely watched nonfarm payroll report, even though it came in broadly in line with expectations. Employers added 428,000 jobs in April, modestly above consensus expectations of around 390,000, but previous months’ gains were revised lower by nearly the same gap (39,000).
Payroll firm ADP’s tally of private sector employment, released Wednesday, surprised to the downside (247,000 jobs added versus nearly 400,000 consensus), so investors may have been hoping for confirmation in the official data of some easing in labor market pressures. Those looking for such evidence got a small victory from average hourly earnings, which rose 0.3% in April, down from 0.5% in March, and below expectations.
US – Equity Market Performance
|Index||Friday’s Close Week Ending 5/6/2022||Weekly (+/-) Point Change 5/6/2022||% Change YTD Week Ending 5/6/2022|
|S&P Midcap 400||2,480.95||-19.34||-12.70%|
SOURCE: BLOOMBERG. THIS CHART IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. PAST PERFORMANCE CANNOT GUARANTEE FUTURE RESULTS.
US Yields & Bonds
Amid a broad rise in Treasury rates, the 10-year U.S. Treasury note yield breached 3.00% for the first time since late 2018, climbing as high as 3.13% last Friday. The yield curve continued its recent steepening trend as long-term inflation expectations—and long-maturity Treasury yields—increased, and more investors eliminated bets that the yield curve would flatten. Thin liquidity in the Treasury market exacerbated the steepening move (thank you, Fed).
Tax-exempt municipal bonds continued to sell off but fared moderately better than U.S. Treasuries at the broad market level. Traders and portfolio managers observed thin liquidity amid persistent outflows from municipal bond funds industrywide and noted that a meaningful share of secondary market trading consisted of tax-loss swapping.
Traders observed lower-than-average secondary trading volumes within the investment-grade corporate bond market and a pickup in new issuance to start the week. The latest deals were priced with attractive concessions and were met with solid demand. Amid risk-off sentiment in the wake of the Fed meeting, investment-grade corporate bonds lost ground, though the asset class outperformed equities. Traders also noted an uptick in overnight demand from Asia, with inquiries mainly focused on longer-maturity bonds.
Last week investors covering positions that would benefit from price declines drove most of the buying activity in the high yield market ahead of the Fed’s announcement on Wednesday. Despite the broad risk-off sentiment, traders noted that some CCC-rated or out-of-favor names traded higher after reporting better-than-expected earnings. There were no new deals announced, given that issuers were waiting for the Fed’s decision due to the continued market volatility.
Buyers in the bank loan market mainly were focused on higher-quality names, while lower-rated loans and market segments more vulnerable to inflationary pressures, such as building products suppliers and retailers, underperformed. Given the overall market volatility, buyers paused in the second half of the week.
US Treasury Markets – Current Rate and Weekly Change
3 Mth: -0.01 bps to 0.81%
2-yr: +0.02 bps to 2.73%
5-yr: +0.13 bps to 3.08%
10-yr: +0.20 bps to 3.13%
30-yr: +0.23 bps to 3.23%
SOURCE: FOR THE WEEK ENDING May 6, 2022. BLOOMBERG. YIELDS ARE FOR ILLUSTRATIVE PURPOSES ONLY AND DO NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. YIELD CHANGES ARE FOR ONE WEEK. PAST PERFORMANCE CAN NOT GUARANTEE FUTURE RESULTS.
Interesting News Overseas
Shares in Europe tumbled amid fears that central banks may have to step up their efforts to control inflation, potentially increasing the risk to economic growth. Lockdowns in China to curb the spread of the coronavirus and the Ukraine conflict added to the uncertainty. The pan-European STOXX Europe 600 Index ended 4.55% lower in local currency terms, while France’s CAC 40 Index dropped 4.22%, Germany’s DAX Index fell 3.00%, and Italy’s FTSE MIB Index lost 3.20%. The UK’s FTSE 100 Index slid 2.08%.
Core eurozone government bond yields mainly rose in tandem with U.S. Treasury yields after the Fed’s 50-basis-point increase. Peripheral euro zone government bond yields tracked yields in core markets. UK gilt yields fell after the Bank of England (BoE) raised rates but cut its forecast for economic growth and warned of a potential recession.
The BoE raised its key interest rate 25 basis points to 1.0%, the highest level since 2009, seeking to dampen inflation. However, the central bank delayed reducing its stockpile of bonds bought under its asset purchase program. The bank also highlighted the potential of the UK slipping into a recession by year-end and warned that inflation could exceed 10% in the fourth quarter. These developments helped to push the British pound to a two-year low.
More European Central Bank (ECB) policymakers appeared to press for an early increase in interest rates after the end of the quantitative easing program sometime in the third quarter. Executive Board member Isabel Schnabel, Bank of France Governor Francois Villeroy de Galhau, Bank of Finland Governor Olli Rehn, and Bank of Austria Governor Robert Holzmann hinted that they would vote for a rate hike as early as July.
On the other side of the planet, Chinese markets fell as Beijing showed no sign of relaxing its zero-tolerance approach to the coronavirus, raising worries about the economic cost of widespread lockdowns. The broad, capitalization-weighted Shanghai Composite Index fell 1.5%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, sank 2.7%.
Relaxing virus prevention and control measures will inevitably lead to large-scale infections, serious illnesses, and deaths, according to a statement released after a meeting of the Politburo, the decision-making body of the Chinese Communist Party. Unlike previous reports, the information did not mention reconciling China’s focus on eliminating the virus with economic growth or minimizing the damage to the economy.
Many of Shanghai’s 25 million residents remain under varying degrees of lockdown even though the city started to ease restrictions as infections have declined. Meanwhile, Beijing announced mass testing and increased restrictions in response to a growing outbreak. In a sign of how the virus restrictions have hit domestic consumption, spending over China’s five-day Labor Day holiday plummeted 43% from a year earlier to CNY 64.7 billion, or roughly USD 9.8 billion.
This Week Ahead
This week the CPI report is expected to show the annual inflation rate eased to 8.1% from a 41-year high of 8.5% in March, while the core rate is seen falling to 6% from 6.5%. Still, the inflation is not expected to fall to pre-pandemic levels any time soon and will remain above the Fed’s 2% target for a long time as supply disruptions persist and energy prices remain elevated. Investors will also keep a close eye on a batch of speeches from Fed officials. Other releases are producer prices, trade price indexes, preliminary reading for the Michigan consumer sentiment, consumer inflation expectations, and the NFIB Business Optimism Index. Meanwhile, the earnings season continues with Tyson Foods, BioNTech, Peloton, Walt Disney, Wendy’s, and AMC Entertainment due to report.
Have a great week.
Stephen Colavito, Jr.
Chief Investment Officer
Perigon Wealth Management, LLC
E: [email protected]
This message is provided for informational purposes and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. Perigon Wealth Management is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, which is available upon request by calling 415-430-4140 or sending an email request to [email protected]