No solace for asset allocators in April. Yields rose once again across the curve, and equity markets continued to give back large portions of 2021 gains. Both stock and bond markets were full of volatility, as the FOMC tightening cycle and the potential for a future recession were focal points.
Equity markets were punished in April, after posting their first positive month of 2022 in March. The S&P index fell by 8.72%, which was the worst April return since 1970. In fact, with the S&P down close to 13% for the first 4 months of the year, it represents the worst four-month start since 1939. Earnings season, while mostly beating street expectations, had some big-name misses (ex: Netflix, Google) creating some wild day-to-day swings.
The defensive consumer staple sector was able to post a slightly positive return (+2.4%), while financials, technology, and consumer discretionary were all down over 10%. Communications services fell the most, down 15.76%. With defensive sectors turning into relative leaders, and growth sectors deep in bear territory, the market is worried about a potential future recession. Most investors agree it will be a difficult task to engineer any kind of “soft landing” in the current environment.
The US yield curve endured a 40-60 basis point upward rate shift, as the “new” correlation of falling bond prices with falling equity markets strengthened. Maybe the most notable change in the April sell-off was how quickly the yield curve went from “being inverted” to a “re-steepening” trend. As yields rose to 4-year highs, support levels broke down as investors grew concerned by incoming inflation data.
All sectors of the bond market fell with higher interest rates - duration profile and credit quality were key. The Bloomberg US Aggregate Bond Index fell by 3.79%. Bonds in the 1-3 year sector only fell by 0.56%, while tenors of 10-years and greater fell by 9.29%. The credit curve also widened as risk premium levels increased with equity volatility. AAA bonds fell by 3.19%, while BBB bonds decreased by 5.74%. Higher beta fixed income including high yield and emerging markets debt fell as well.
Broad municipal bond portfolios fell 2.77%, down almost 9% year-to-date. While no municipal bond sector was shielded from lower prices, the repricing in this sector has created a much better tax-free yield opportunity. While high-grade muni sectors traded as low as 60% of their comparable treasury yield in 2021, these ratios have shifted much higher (80-90%) this year. This may create some good opportunities for taxable equivalent yield gains for investors.
While the Ukraine war and Covid pandemic trends continue to be on the minds of all investors, it was clear that market participants were focused on inflation data and the FOMC’s reaction to that data. In essence, the whole month of April was a build-up to today’s May 4th Fed meeting, and the meetings that follow.
Stronger inflationary tones were the norm last month. On April 1st, the monthly non-farm payroll numbers came in close to expectations, but the higher than expected average hourly wage figures sent stocks lower and set the tone for volatility all month. CPI was reported close to expectations which still put the headline figure at a four-decade high. PPI recorded its highest monthly increase on record. At the close of April, Q12022 GDP estimates came in much lower than expected (-1.45), but the GDP price indices rose. Also, the employment cost index rose more than economists thought and spending increased.
Economic data as stated was mixed throughout the month. Employment remains strong, and one weekly jobless claim report last week was the lowest (except for one report) since 1968. But other areas seem to be slowing slightly under the inflationary pressures. Houses (most likely due to higher interest rates) have shown some early signs of slowing.
The FOMC may have been the biggest market catalyst last month as minutes, comments and speeches kept rates and equity markets on alert.
- April 5th: Lael Brainard, a normally dovish member of the FOMC, discussed a rapid quantitative tightening, as soon as May. Bonds sold off violently and the curve steepened
- April 6th: Fed minutes suggested the FOMC discussed shrinking the balance sheet by $95 billion per month, and many members preferred to raise the Federal Funds rate in 50 basis point increments.
- April 19th: Fed governor Bullard floated the idea of raising rates in increments of 75 basis points. Bonds fell to 3-year highs, and the 30-year US Treasury Bond breached 3% for the first time since March 2019.
- April 21st: Chairman Powell spoke on a panel hosted by the IMF. He “blessed” 50 basis point increments, and explained that he favors a “front-loaded Fed” to get the funds rate to neutral. Three 50 basis point moves (one at each of the next fed meetings) were now firmly priced into markets. Plus, the potential for the funds rate to go above neutral is a firm possibility.
- April 22nd: Stocks crumbled under the weight of other FOMC officials entertaining the idea of 75 basis point moves.
By the end of April, over 250 basis points of tightening is being priced into the market for next year. Along with a 50/50 chance of 75 basis point increases, and an aggressive quantitative tightening of the Fed balance sheet.
Piton has been cautious on inflation and fed policy within all of our portfolio mandates. As such, we have maintained a strategic short-duration posture in our portfolios. Please compare our returns to any of your fixed income allocations/providers for discussion. We believe Piton is adding alpha with a lower standard deviation. Active macro-management in the fixed income world is very important at this time.
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