Inflation In the Driver’s Seat – Fort Pitt Capital Group Quarterly Commentary
The nearly two-year winning streak for U.S. equity markets ended in the first quarter of 2022. Broad equity indices registered their first quarterly loss since the depths of the pandemic in early 2020. The S&P 500 Index declined by more than 12% by early March before staging an impressive rally in the closing weeks of the quarter. The S&P 500 finished the quarter with a moderate decline of 5%, while growth stocks, international markets, and small-cap equities posted even larger declines.
Investors did not have to strain to identify the culprits behind the market declines. An abbreviated list includes inflation spiking to 40-year highs, a hawkish Fed policy shift, surging bond yields, flagging earnings momentum, and finally – Russia’s invasion of Ukraine. While equity returns were negative for the quarter, stocks showed impressive resiliency against a backdrop of multiple negative developments.
Bonds offered no cushion to the equity market drawdowns. The intermediate-maturity Bloomberg U.S. Aggregate Bond Index suffered a 5.9% decline, marking one of the worst quarterly results on record. Longer maturity bonds were hit even harder, with the Bloomberg U.S. Long Credit Index down more than 11%. Bonds across the credit and maturity spectrum were repriced lower as investors adjusted to elevated and persistent inflation pressure and expectations for the Federal Reserve’s much more aggressive monetary tightening.
As expected, economic growth slowed from the unsustainable pace registered in 2021. Early forecasts of 3.5% to 4.5% GDP growth in 2022 now look optimistic, given headwinds from tighter monetary policy and the negative consumer impact of higher interest rates and inflation. However, we see little probability of an outright economic contraction over coming quarters, given robust capital spending, resilient labor markets, and well-positioned consumers. Healthy wage growth, high levels of excess savings, and strong balance sheets are keeping consumers engaged.
As always, visibility on economic conditions and growth decreases as we look beyond the next few quarters. However, it’s becoming increasingly clear that inflation will be the dominant driver of outcomes for both the economy and financial markets. The Federal Reserve has made an aggressive pivot towards reigning in inflation, which is currently hovering around 8% – the fastest pace since 1982. The Fed certainly has the tools to bring down inflation, but easing price pressures without choking off economic growth has proven a difficult needle for the Federal Reserve to thread in the past.
Russia’s invasion of Ukraine became a top investor concern in the latter part of the first quarter. While geopolitical tensions have a history of being ignored by the market, this time could be different given the perceived breakdown in the post-Cold-War order. A tangled web of secondary effects – particularly commodity and supply chain issues – also combined to roil markets during the quarter. Russia is a major energy producer/exporter, and Russia and Ukraine combine for roughly 25% of global grain production. As a result, consumers and financial markets are closely watching the broad-based spike in commodity prices. This complicates the Fed’s challenge of reducing inflationary pressures in the near term.
Several indicators point to a peak in inflation over the next several months. Price pressures will likely ease as demand becomes more evenly balanced between goods and services and year-over-year comparisons are normalized. Higher interest rates and the end of stimulus payments should also translate into lower consumer demand. Fixed income markets, consumer expectations, and economic surveys also anticipate lower inflationary pressure over time. However, investors won’t wait forever for inflation to cool, and elevated stock market valuations will be at risk if consumer prices continue to climb at near double-digit rates in the coming quarter.
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Any opinions expressed are opinions held at the time of publishing and are subject to change. It does not constitute an offer, solicitation, or recommendation to purchase any security. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Past performance does not guarantee future results. The performance shown is for illustrative purposes only and the intent is to show the performance of certain segments of the markets. This information is not reflective of the performance of any FPCG client, or the impact of security selection on actual client portfolios. Actual results and developments may be substantially different from the expectations described in the forward-looking statements included herein.
The S&P 500 is a broad-based index of 500 stocks, which is widely recognized as representative of the equity market in general. The Bloomberg U.S. Aggregate Bond Index is a broad-based index of intermediate term investment grade bonds traded in the U.S. These indices are unmanaged and may represent a more diversified list of securities than those recommended by FPCG. In addition, FPCG may invest in securities outside of those represented in the indices. The performance of an index assumes no taxes, transaction costs, management fees or other expenses. Additional information on any index is available upon request
