April 2022 Stonemark Market Commentary

April was the worst month of the year so far for equity markets as the S&P 500 fell 8.80% (-13.31% YTD), the NASDAQ underperformed with a 13.26% drawdown (-21.16% YTD), the Dow Jones Industrial average shed 4.91% (-9.25% YTD), the Russell 1000 Value losing 5.75% (-6.93% YTD) & the Russell 1000 Growth falling by 12.12% (-20.22% YTD). In fact, April’s performance was the worst since March of 2020 when all of the major indices fell double-digits at the beginning of the COVID-19 pandemic.

Only one sector, Consumer Staples (+2.40% for the month of April) ended the month in positive territory while Communication Services (-15.76% for the month of April), Consumer Discretionary (-13.03% for the month of April), Information Technology (-11.31% for the month of April) & Financials (-10.02% for the month of April) all saw double-digit declines. The sell-off in equities came as inflation data continued to come in at record-high prints & worries that the Federal Reserve (“the Fed”) would have to be more aggressive in reducing the market-supporting monetary policy that has been in place for more than two years.

As of the end of April, according to FactSet, 55% of companies listed on the S&P 500 have reported 1st quarter earnings results, with 80% of those companies beating their earnings estimates. However, the magnitude by which these companies are exceeding their earnings estimates is well below the 5-year average – that is, those companies who have surpassed earnings estimates are doing so by roughly 3.4% compared to the 5-year average of 8.9%. Looking at the graphic below, companies within the Industrials (92% beating earnings estimates), Consumer Staples (89% beating earnings estimates), Healthcare (85% beating earnings estimates) & Information Technology (82% beating earnings estimates) sectors are performing the best when it comes to exceeding their earnings estimates while companies within the Consumer Discretionary (37% missing earnings estimates), Energy (33% missing earnings estimates) & Communication Services (29% missing earnings estimates) are the laggards.

When it comes to year-over-year earnings growth, the S&P 500 as a whole is experiencing 7.1% year-over-year growth, which, while it is still positive that earnings are growing, marks the lowest year-over-year earnings growth since the 4th quarter of 2020 when we saw earnings grow by 3.8% on a year-over-year basis. Looking at the graphic below, to no surprise, the Energy sector is leading the way with 257.8% year-over-year growth. The next sectors experiencing the highest year-over-year earnings growth are the Materials (38.7% year-over-year) & the Industrials (32.0% year-over-year) sectors, while the Consumer Discretionary (-34.0% year-over-year) & Financials (-20.8% year-over-year) sectors are the only two sector experiencing negative growth.

Furthermore, of the companies that have reported their 1st quarter earnings results, 53 of those companies have issued negative EPS guidance for the 2nd quarter of 2022 while 23 of those companies have issued positive EPS guidance for the 2nd quarter of 2022. As companies continue to struggle with the impacts of inflation on their business, as of the end of April, CFRA has revised their 2nd quarter earnings results for the S&P 500 to come in at $54.96 – down 1.2% compared to the earnings estimates of $55.62 that they were forecasting as of April 8th. With regards to FY 2022 earnings, as of the end of April, CFRA is now forecasting earnings for the S&P 500 to come in at $227.47 – a 0.6% increase from the $225.89 that they were forecasting as of April 8th & a 4.1% increase from the $218.48 they were forecasting as of the end of 2021. With the S&P 500 ending the month of April at 4,131, we are now trading at a 12-month forward price-to-earnings multiple (“P/E multiple”) of 18.1x FY 2022 earnings estimates. According to FactSet, a P/E multiple for the S&P 500 of 18.1x is below the 5-year average of 18.6x but still well above the 10-year average of 16.9x. Despite having come down significantly from the 21.8x P/E multiple that it ended 2021 at (based on a 4,766-closing price on December 31st 2021 for the S&P 500 & FY 2022 earnings estimates of $218.48), rising interest rates, continued inflation & the ongoing supplychain constraints could continue to lead to multiple compression. If P/E multiples continue to compress & we get closer to trading at the 10-year historical average P/E multiple of 16.9x, based off of CFRA’s FY 2022 earnings estimates of $227.47, that would imply a year-end price target of 3,844 – roughly 6.9% below April’s closing price. Should we end 2022 at 3,844, that would mark an exactly 20% decline from the S&P 500’s all-time intraday high of 4,818.62 that we saw on January 4th of this year. Given the volatility that we have seen so far in 2022, another 6% drawdown over the course of the next 7 months does not seem all that crazy. That being said, we will continue to monitor our portfolios & adjust our positioning accordingly.

Despite falling to close to $90/barrel during the month of April, West Texas Intermediate crude oil (“WTI crude”) climbed back above the $100/barrel threshold to finish out the month. Throughout the course of April, there was somewhat of a “push-pull” in the price of oil. The fall in oil prices came as officials in Shanghai & other parts of China began reinstituting COVID-19 lockdowns for tens of millions of Chinese citizens in an attempt to fulfill its “Zero COVID Policy”, leading oil traders to shift to selling on the prospects of weakened demand for oil & oil-derived products. Counteracting China’s lockdowns is the ongoing war in eastern Europe as we now enter the third month of Russia’s invasion of neighboring Ukraine. Russia’s continued aggression in Ukraine has led to more & more countries sanctioning Russia, with several countries vowing to end their reliance on Russian-produced oil & natural gas. However, looking at Figure 1 below, the current shape of the WTI curve would indicate that there may be some relief from these multi-year high price levels.

Figure 1 is a perfect example of what is referred to as “backwardation” – a term used in the futures markets to describe an instance when futures contracts for a commodity are lower than the current price in the spot market & are in a downward sloping curve where the price of the commodity is lower the further out on the futures curve that you go. Backwardation occurs as a result of two primary functions, which are 1) higher demand for the commodity in the present day & 2) a shortage of the commodity in the spot market. For some comparison, Figure 2 below shows the WTI futures market from the beginning of 2020 when the futures market was in “contango” – a term that is used when futures prices are higher than the current spot price & are higher the further out on the futures curve that you go.

A futures market in “contango” (the opposite of one in “backwardation”) can be caused by several factors including rising future inflation expectations, forecasts for future supply disruptions & the carrying cost of the observed commodity. However, the contango market we saw in 2020 was the result of something different, which was that demand for oil & oil-derived products had essentially evaporated overnight as the world shut down. The screeching halt in demand led to the companies that take physical delivery of oil for storage & refinement being forced to get out of their futures contracts that were close to expiration as they were at 100% of their storage capacity. Furthering deepening the WTI sell-off that we saw in 2020 & sending the futures markets further into contango was the fact that traders, who are market participants that speculate about where future WTI prices will be but never expect to actually take physical delivery of the commodity, were forced to sell their contracts at whatever price they could get (some even selling in negative territory). One could also make the argument that future expectations of rising inflation also factored into sending markets into contango as interest rates were at nearly 0% & inflation was well below the 2% level that the Fed has set as its long-term inflation target.

So what does this mean for the price of oil? Historically, a commodities market that is in backwardation has been used as a leading indicator with the expectation that the spot price of the commodity being observed will fall in the future. However, that is under normal circumstances & as we have reiterated for the last 2+ years is that we are currently anything but normal. As we enter the summer months, which is typically a period of seasonally high demand for oil-derived products, combined with the ongoing lack of supply resulting from Russia’s invasion of Ukraine could prove to be the perfect storm that sends oil prices even higher. The result of even higher oil prices would have a ripple effect through the entire economy. Everything from gas prices to plane tickets will go up as airlines are forced to pass on a portion of the increased jet fuel costs onto the consumers. Expect that companies who manufacture hard goods (i.e. – televisions, household appliances, etc.) who now have to pay a premium in all stages of the supplychain to increase the prices for their goods. This is because companies really only have two choices when faced with rising input costs; 1) pass a portion of those increased input costs (in this case, rising oil prices) via raising the price they charge consumers for their goods or 2) absorb the costs, which will impact the bottom-line of their financial statements. The choice between these two options is a delicate balancing act, which requires companies to make a very calculated decision. On one hand, publicly-traded companies have a duty to their shareholders to maximize profits, so absorbing 100% of rising input costs, which negatively impact the bottom-line, is not in the best interests of the shareholders. On the other hand, passing these rising input costs onto the consumer is also a risky venture. If a company allows 100% of the rising input costs to flow through to the end consumer by raising prices for their goods, the company will inevitably “price out” some potential consumers who now view the cost of the good to outweigh the benefits that they would gain. While listening to company’s 1st quarter earnings calls, just about every management team has been mentioning rising oil prices & inflation as negatively impacting their bottom lines, which would suggest that companies are absorbing a portion of these increasing costs. However, looking at the monthly consumer price index (“CPI”), which measures the price movements of a basket of goods & services on a month-over-month & year-over-year basis, would suggest that companies are also passing some of these costs onto the end consumer. March’s CPI print (these data releases are on a one-month delay, so March’s CPI was reporting in April) came in at 8.5% on a year-over-year basis. On a month-over-month basis, CPI rose by 1.2% during the month of March – the largest month-over-month increase in CPI since September 2005, which came in at 1.4%. With the Fed vowing to remain aggressive in combatting inflation, we, along with everyone on Wall Street, will eagerly be waiting to see if & when the Fed can get inflation under control.

One of the most talked about asset classes, cryptocurrency, has had quite a brutal start to the year. With lots of talk on Wall Street that cryptocurrencies could be used as an “inflation-hedge”, what we have seen thus far in 2022 would suggest that cryptocurrencies, like equities, are not immune to soaring inflation. While adding a digital currency to a portfolio has the ability to provide diversification, we can’t ignore the fact that, compared to more traditional assets such as equities & bonds, cryptocurrencies are still a relatively new asset class (the 1st Bitcoin was mined on January 3rd 2009). Looking at the graphic below, every major cryptocurrency, both mainstream names such as Bitcoin & Ethereum as well as “meme-coins” like Dogecoin & Ripple, has started 2022 with double-digit losses.

Despite cryptocurrencies gaining corporate-backing (for example, software company, MicroStrategy Inc., made headlines in 2020 when it announced that it was converting $250 million worth of cash on its balance sheet to purchase 21,454 Bitcoins. As of its most recent quarterly filing, the company said that it now owned 129,218 Bitcoins with an average price of $30,700, which equates to roughly $4 billion invested in Bitcoin) & countries like El Salvador adding Bitcoin to its balance sheet & adopting Bitcoin as a legal tender, cryptocurrencies have sold off significantly to start 2022.

Adding to the inherent volatility that is often associated with cryptocurrencies, is the increasing scrutiny coming out of Congress. While this is not a theme that is new to 2022 (Congress has been wary of cryptocurrencies basically since their inception as they believe the untraceable digital currencies can be used to fund illegal activities), anytime the topic of cryptocurrencies is brought up on Capitol Hill, volatility in the cryptocurrency markets ramps up. According to Forbes, as of the end of 2021, Congress had introduced 35 different bills related to cryptocurrencies, which fall into three sub-categories: 1) cryptocurrency regulations, 2) applications of blockchain technology & 3) introducing a central bank digital currency (“CBDC”). While all of the bills currently up for debate in Congress fall into one of these three categories, they all share one common theme that seems to get the bulk of the attention. That theme – do cryptocurrencies need to be regulated (and if so, how?) & if cryptocurrency-specific legislation is needed. Until there is some clarity on Capitol Hill, whether that be through these bills getting passed into law or thrown out, we would expect the volatility in the cryptocurrency markets to continue.

As we move into the month of May, Wall Street’s primary focus will turn back to the Fed as the FOMC will hold another policy meeting May 3rd & 4th. It is widely expected that the Fed will raise interest rates by another 50bps to a targeted range of 0.75-1.00%. According to the CME Group’s FedWatch tool, as of the end of April, market participants are pricing in a 50bps rate hike at the May meeting followed by a series of 25-50bps rate hikes at every remaining FOMC meeting for the rest of the year to bring the targeted range to 2.75-3.00%. With a 50bps interest rate hike almost certain, investors will be paying more attention to what Federal Reserve Chairman, Jay Powell has to say about future rate hikes as well as providing some insight into when the Fed expects to begin reducing the size of its balance sheet. While interest rates & monetary policy will be at the forefront of Wall Street’s mind, there are plenty of other potential market-moving catalysts that we will keep an eye on. We will continue to monitor the ongoing Russia-Ukraine conflict & the impact that a drawn-out conflict will have on the financial markets & global economy. There are still roughly 45% of the S&P 500 who have yet to report their 1st quarter earnings results, which we will be closely following as earnings season thus far has not been too friendly to equities. With plenty of uncertainty on numerous fronts, we expect that volatility in the equity markets will remain at elevated levels for May & beyond. With all of that in mind, we will continue to monitor any & all catalysts as we navigate what we expect to be a volatile next few months. Finally, we will keep everyone apprised of any significant trends or shifts in trends that we are seeing in the financial markets & broader economy that warrant bringing to your attention.

As always, please feel free to reach out with any questions or concerns.

Stay Safe & Stay Healthy!