Mullaney on the Markets | Earnings Revisions Offer Optimism After ‘Cruel’ April

By Michael Mullaney | Director of Global Markets Research
Published May 2022

Fans of T.S. Eliot will recall that “April is the cruelest month.” The epigraph of what is often considered to be the poet’s  1923 magnum opus, “The Waste Land,” unfortunately rang true this year, as the S&P 5001 fell by -8.72% during the month. This represented the largest monthly loss in the index since March 2020, the result of continued headwinds. Most of the challenges are by now familiar, from the war in Ukraine and rampant inflation to an increasingly hawkish Federal Reserve and an ongoing Covid-19 pandemic that continues to disrupt a number of global supply chains. The cruelty of April, however, also saw the market digest a headline “miss” for the Q1 2022 GDP report.

When the first quarter loss for the S&P 500 is added to April’s results, the year-to-date -12.92% return represents the worst start to a year for the U.S. stock market on record since 1957, the year Standard & Poor’s began tracking the 500 stocks that comprise the index. Marketwatchers would have to go back to 1939 to find a worse start for the index, which was launched in in 1926 and followed just 90 stocks for its first 31 years.

Once again, bonds provided little-to-no relief from the stock market malaise as the Bloomberg U.S. Aggregate Bond Index2 of investment grade securities dropped by -3.79% during April, its worst monthly performance since August 1980. Bonds were hampered by a rapid increase in interest rates that saw the yield of the 10-year Treasury bond3 rise from 2.32% to 2.89% during the month. This represented the biggest jump in rates since December 2009. At -9.50% year-to-date, the bond market benchmark is off to its worst start to a year on record based on data back to 1977.

Defensive Sectors in Vogue

Of the eleven sectors that comprise the S&P 500, only Consumer Staples — a sector known for its defensive characteristics — was able to post a gain for the month at +2.56%. Stocks in that sector that had done well during the height of the pandemic (i.e., Kimberly-Clark, Kraft Heinz, Campbell Soup) also outperformed during April’s “risk-off” trading environment.

Three sectors posted double-digit losses for the month: Information Technology (-11.28%), Consumer Discretionary (-13.00%) and Communication Services (-15.62%). These sectors were negatively impacted by their exposure to FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), which fell by -22.05% on average and by -15.72% on a capitalization-weighted basis. These stocks were also hurt by the increase in interest rates, given the “long-duration” nature of their future expected earnings streams. Amazon alone accounted for over 10% of the loss generated by the S&P 500 during the month. The company reported just a 7% increase in first-quarter sales (the lowest in 12-years), operating income that was 31% below consensus estimates, and posted its first quarterly loss in seven years. The stock fell by -14% on the day of the report and was down by -23.75% for the month.

Year-to-date (YTD), Energy remains in the pole position with a return of +36.85%, nearly mirroring the +35.65% gain in crude oil prices since last year. Communication Services is the laggard YTD at -25.68%, hurt by the -40.4% drop in Meta Platforms (Facebook) and a -68.4% loss in Netflix, both suffering from a waning subscriber base.

As mentioned, “risk-off” was the dominant investment theme for the month as high-quality stocks (those rated “B+” or higher by Standard & Poor’s) beat those rated “B” or lower (-6.14% to -11.10%) and stocks in the lowest beta quintile4 of the S&P 500 trounced those in the highest beta quintile by over 12%.

Size also outperformed during April as the Russell 1000 Index5 of large-cap stocks beat the Russell 20006 Index of small-cap stocks by an even 1%, -8.91% to -9.91%. Interestingly, the S&P 600 Index7 of small-cap stocks beat both Russell benchmarks with a return of -7.81%. The outperformance is a byproduct of the Standard & Poor’s convention of excluding stocks that have not reported four consecutive quarters of positive earnings, itself a quality ranking system.

In terms of style, Value continued its domination over Growth. The Russell 1000 Value8, the Russell Mid Cap Value9 and the Russell 2000 Value10 indices beat their Russell Growth10 counterparts by an average of +5.42% across the three market capitalization ranges during April and by +13.95% on a year-to-date basis.

International stocks fared better than those in the U.S. domestic market during the month, particularly in local currency terms. The MSCI EAFE Index11 of developed-market international stocks fell by just -1.30% and the MSCI EM Index12 dropped by -3.50%. While currency losses versus the U.S. dollar during April hindered the returns of each index, both were still able to outperform domestic stocks, MSCI EAFE at -6.38% and MSCI EM at -5.55%. During the month, the DXY Index, an index that calculates the return of the dollar versus a basket of the currencies representing the six largest trading partners of the U.S., posted a gain of +4.73%, while the MSCI EM Currency13 Index fell by -2.82% versus the dollar.

Year-to-date returns tell a similar story. The MSCI EAFE Index returned -4.86% in local currency terms, but -11.80% in  U.S. dollar terms, with the DXY Index gaining +7.62% against the foreign currencies. Emerging market returns were lower than developed international markets, with the MSCI EM Index down by -9.35% in local currency terms, but by -12.09% in dollar terms as the MSCI EM Currency Index dropped by -2.25% during the year. In general, the dollar continued to benefit from its reserve currency status and a higher interest rate environment than many other countries.

Looking for the Positives

The war in Ukraine continues to dominate the news as Putin and Russia have given no signs of tempering the aggression any time soon. Putin’s recent appointment of Gen. Aleksandr Dvornikov to command all forces in Ukraine is concerning given that he was previously responsible for Russia’s military efforts in Chechnya, Crimea and Syria and has been dubbed as “the butcher of Aleppo and Grozny” based on his brutal, inhumane war tactics.

During the month, Russian Maj. Gen. Rustam Minnekaev gave an indication as to what Putin’s game plan might be: capture Mariupol, move on to Odessa, and then on to Transnistria, the Russian-speaking sliver of Moldova. Annexing Mariupol and Odessa would cut off Ukraine’s link to maritime commerce via the Baltic Sea. As of right now, there is no end in sight for the conflict and the chance of further escalation is high.

Inflation reports released during April were also daunting. At 8.5%, the consumer-price index (CPI)14 for March rose at its fastest pace since 1981 and the personal-consumption expenditures price index (PCE)15 increased by 6.6%, its highest mark since 1982. The Core PCE (the Fed’s preferred inflation measure) increased by 5.2%, more than double the Fed’s 2% target.

Given these releases, members of the Federal Open Market Committee (FOMC), including Chairman Powell himself, began to indicate that one or more 50-basis-point16 hikes in the Fed Funds17 rate would probably be needed to quell inflation. St. Louis Fed President (and FOMC voting member) James Bullard warned that a hike (or hikes) of 75 basis points might be necessary.

The Fed also signaled what its likely plan to reduce its balance sheet might look like: allowing $95 billion of securities to mature every month without repurchase (“runoff”) beginning in June, nearly double the $50 billion pace of their last balance sheet reduction efforts that started in 2017. Fed officials have indicated that they would like to shrink holdings by a total of $3 trillion over the next three years, compared to $800 billion between 2017 and 2019.

While COVID cases in the U.S. are beginning to rise again, the large weekly percentage change in cases reported by media sources are off low bases. The actual number of reported cases remains low based upon historical observations. That being said, the new Omicron subvariant, BA.2, should not be taken lightly. According to the CDC, it now accounts for 85% of all reported cases in the United States. A new strain, BA.2.12.1, which has been spreading in New York, has an estimated growth advantage (transmission) of about 25% over the BA.2 variant.

The COVID news out of China is more alarming.  Lockdowns expanded from Shanghai to Beijing and 87 of China’s 100 largest cities now have some form of restriction on movement and activities. This continues to have a negative impact on global supply chains, with the semi-conductor industry under the greatest strain.

On the positive side, S&P 500 earnings estimates continue to be revised higher. Collectively, S&P 500 constituents boosted estimates for profit growth from 6% to 8% in the current quarter and from 7.6% to 10.2% for the year as companies have generally been able to pass through their increase in costs to consumers and maintain margins.

Also, the -1.4% reported drop in gross domestic product for the first quarter was misleading, as the bulk of the loss was due to a +17.7% gain in imports, which is treated as a detractor from U.S. economic activity. The surge in imports was largely due to an easing of bottlenecks at U.S. shipping ports, allowing goods to finally reach the hands of U.S. consumers. Private Sales to Domestic Purchasers, a measure of true domestic demand, was up 11.5% during the quarter and continues to reflect a healthy consumer base.

Volatility is and should remain elevated.

Terms and Definitions:

[1] The S&P 500 Index is a registered trademark of the McGraw-Hill Companies, Inc. and is an unmanaged Index of the common stocks of 500 widely held U.S. companies.

[2] Bloomberg Aggregate Bond Index a broad-based fixed-income index used by bond traders and the managers of mutual funds.

[3] Yield of the 10-year Treasury Bond: Yield refers to the earnings generated and realized on an investment over a particular period of time. It’s expressed as a percentage based on the invested amount, current market value, or face value of the security. The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity.

[3] A measure of a portfolio’s market-related risk or its price movement in relation to a benchmark.  Securities with betas higher than 1.0 have been, and are expected to be, more volatile than the benchmark; securities with betas lower than 1.0 have been, and are expected to be less volatile than the benchmark.

[4] The Russell 1000 Index is a stock market index that tracks the highest-ranking 1,000 stocks in the Russell 3000 Index, which represent about 93% of the total market capitalization of that index.

[5] The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index.

[6]S&P 600 Index: The S&P SmallCap 600® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

[7] The Russell 1000® Value Index contains stocks included in the Russell 1000® Index displaying low price-to-book ratios and low forecasted growth values.

[8] The Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 31% of the total market capitalization of the Russell 1000® Index. The Russell Midcap® Value Index contains stocks included in the Russell Midcap® Index displaying low price-to-book ratios and low forecasted growth values.

[9] Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

[10] The Russell 1000® Growth Index measures the performance of the largecap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 years); Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

[11] MSCI EAFE Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada

[12] MSCI EM (Emerging Markets) Index:  Captures large and mid cap representation across emerging markets countries covering approximately 85% of the free float-adjusted market capitalization in each country.

[13]MSCI EM Currency Index: The MSCI Emerging Market Currency Index in USD measures the total return of 25 emerging market currencies relative to the US Dollar where the weight of each currency is equal to its country weight in the MSCI Emerging Markets Index.

[14] CPI: The Consumer Price Index (CPI) is a measure of the average change overtime in the prices paid by urban consumers for a market basket of consumer goods and services.

[15] PCE: In the United States, the Core Personal Consumption Expenditure Price Index provides a measure of the prices paid by people for domestic purchases of goods and services, excluding the prices of food and energy. The core PCE is the Fed’s preferred inflation measure.

[16] Basis points refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points and 0.01% = 1 basis point.

[17] The federal funds rate is the target interest rate set by the FOMC. This is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. The FOMC sets a target federal funds rate eight times a year, based on prevailing economic conditions.

Important Disclosure Information:

Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940.  The views expressed in this commentary reflect those of the author as of the date of this commentary.  Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views.  Past performance is not an indication of future results. Discussion s of securities, market returns, and trends are not intended to be a forecast of future events or returns.   

Actual future events could differ substantially. All figures are presented in USD unless otherwise noted. Discussions of specific securities are for informational purposes only. It should not be considered a solicitation or an offer to buy or sell any security. It is not known how securities will perform in the future.

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