The global equity market remained volatile last week with the MSCI AC World Index falling for a fifth consecutive week (down 1.5% on the week). In the United States, equity markets were whipsawed on Wednesday and Thursday, but the Dow Jones and the S&P 500 both closed the week just 0.2% lower. The NASDAQ continued to correct – slipping 1.5%. Markets overseas were not spared with European and Japanese stocks each down 4.1%. The nominal 10-year U.S. Treasury yield continued to climb higher – rising 19-basis- points – as the Federal Reserve moved forward with tightening monetary policy.
The April consumer price index (or CPI) is expected to show U.S. inflation trending lower. This could be welcomed news, but the details of the report will be key as investors digest whether it is largely a machinal move lower or part of a more substantial trend. President Biden has already announced that he will address the nation following the release of the report. We do not envision the report deterring the Federal Reserve from hiking rates at their next couple of meetings.
We would remind investors that bear markets are often followed by substantial and lengthy stock market recoveries.
Keeping an Eye on Inflation
The key event this week will be on Wednesday when the April consumer price index (or CPI) will be released. Consensus expectations are calling for U.S. inflation to fall from 8.5% in March to 8.1% in April. Core inflation, which excludes the volatile categories of food and energy and is often thought to more accurately reflect the true pace of inflation in the underlying economy, is expected to retreat from 6.5% to 6.0%. If accurate, this downtrend may be welcomed by both financial markets and policymakers.
However, the Federal Reserve will probably see this level of inflation as still too high and remain on a path to hike interest rates by 50-basis-points at least two or three more times. This is in line with what Atlanta Fed president Raphael Bostic told Bloomberg news recently when he stated that, “I think we can stay at this pace and this cadence and really see how the markets evolve…We are going to move a couple times, maybe two, maybe three times, see how the economy responds, see if inflation continues to move closer to our 2 percent target, then we can take a pause and see how things are going.”1 We find it interesting that financial markets have largely ignored the dialing back of Fed rate hike expectations (see figure 1) and that financial conditions are already approaching something closer to neutral (see figure 2). This may take some pressure off the Federal Reserve later in the year should inflation ease some. It is very early days, but these trends could be tentative signs that the odds of a “softish” landing may be rising very slightly.
A Stabilization in Bond Yields is Critical
The recent market sell-off has been felt most acutely in the technology sector with the NASDAQ officially in bear market territory and off 27.6% from its all-time high (though we would remind investors to keep the recent sell-off in perspective with the NASDAQ still 69.4% above its March 23, 2020 low). Some of this is due to a normalization in behavioral patterns with individuals less tied to their homes as life returns to something more akin to normal (see figures 3-4), while the rest may be bound to the sharp rise in bonds yields with technology stocks particularly sensitive to bond yields as investors discount future earnings (see figure 5). It is hard to know exactly when bond yields will stabilize, but less Fed surprises moving forward should be helpful and trendlines suggest we may be nearing a peak (see figure 6).
The Case For Staying Invested
Market volatility is likely to stay elevated during this period of economic transition. However, history suggests that these types of events can change quickly and that trying to time the market is nearly impossible. History also indicates that there is little reason to try. Since 1990, simply staying invested would have netted an investor an average annual return of 10.8%. However, if an investor tried to time the market and missed the 20 best days, the average annual return drops to just 6.3% (see figure 7). We would also point out that 8 of the top 10 best days have occurred within just two weeks of the 10 worst days. This past week was a perfect example with the Dow Jones Industrial Average up 932.3 points on May 4th and down 1,063.1 points of May 5th. Unfortunately, exiting positions as a result of volatility is usually a losing endeavor and typically weakens returns. We would also remind investors that bear markets (defined as a sell-off that is 20% or more), are typically followed by periods of substantial and lengthy recoveries (see figure 8).
|S&P 500 Bear Market Recoveries|
|Trough||Peak||Trough to Peak %||Number of Days|
|Average # of Days||686|
|Index||Weekly Chg change in percent||YTDyear to date change in percent||12 Months 12 month change in percent||Div. Yield division yield in percent|
|Instrument||Weekly Chgchange||YTDyear to date||12 Months12 month change||Level|
|10-Year Treasury Yield (%)||19.2 bps||161.6 bps||155 bps||3.13%|
|Index||Weekly Chg change in percent||YTD year to date in percent||12 Months||Div. Yield division yield in percent|
The Week Ahead
|5/10||6:00||NFIBNational Federation of Independent Business Small Business Optimism||AprApril||92.9||93.2|
|5/11||8:30||CPI Consumer Price Index MoM Month over Month||AprApril||0.2%||1.2%|
|5/11||8:30||CPI Consumer Price Index Ex Food and Energy MoMMonth over Month||AprApril||0.4%||0.3%|
|5/11||8:30||CPI Consumer Price IndexYoY year on year||AprApril||8.1%||8.5%|
|5/11||8:30||CPI Consumer Price IndexEx Food and Energy YoY year on year||AprApril||6.0%||6.5%|
|5/13||10:00||U. of Mich Sentiment||May P||64.0||65.2|