Last week was a challenging one for stocks as incoming macro data pointed to continued inflationary pressures and an erosion of consumer confidence. CPI data was released on Wednesday and showed core inflation accelerating to +0.6% sequentially in April, after it had slowed to just +0.3% m/m in March. On a y/y basis, headline CPI was +8.3% while core CPI was +6.2%, both of which were 20bp higher than consensus. A day later, headline producer price inflation (PPI) also exceeded expectations at +11.0% y/y. And on Friday, the University of Michigan’s Consumer Sentiment gauge reversed its gains from April and fell to 59.1 in the preliminary May reading, the lowest print in more than 10 years.
This combination of macro data produced a classic “flight to safety” response from investors. Stocks were down as the equity risk premium expanded. Defensive sectors provided some protection, while cyclicals and growth sectors underperformed. High quality bonds rallied as Treasury yields fell, but credit spreads widened. And the US dollar rallied to a two-decade high against a trade-weighted basket of foreign currencies.
Meanwhile, oil prices remain stubbornly high thanks to the ongoing war in Ukraine, resulting in all-time high gasoline prices at the pump for American consumers. Mortgage rates also rose slightly last week, creating another headwind for American consumers looking to buy their first home or relocate.
*Economy & Earnings – Annualized US GDP growth fell to -1.4% in Q1 on headwinds from trade, private investment, and government spending. Personal consumption remains strong, however, suggesting growth should resume for the balance of the year. Consensus 2022 GDP stands at +2.7%.
*Equity Valuation – The S&P 500’s fwd P/E of 16.6x is above the historical average, and long-term valuation metrics like CAPE (cyclically adjusted P/E ratio) suggest that compound annual returns over the next decade are likely to be in the single digits. That said, many growth stock valuations are at multi-year lows after the recent selloff, suggesting future returns in some sectors could be above-average.
*Interest Rates – Rates have risen across the curve in early 2022 as the market prices in a number of Fed Funds rate hikes. Fed Fund Futures markets are currently pricing in a total of ten or eleven 25bp rate hikes in 2022, with an implied Fed Funds target rate floor of 2.50% – 2.75% by year end.
*Inflation – Inflation is currently high on a y/y basis as supply chain disruptions, labor shortages, and rising energy prices have impacted input costs for many businesses. The Fed has begun raising overnight interest rates in order to tame inflationary pressures.