In this week’s Monday Market Insights, we discuss how equity market prices continue to fluctuate with Russia/Ukraine headlines, revisit our “slower growth” narrative, and examine the recent rise in high yield corporate credit spreads. In our Chart of the Week, we highlight how market volatility is elevated, but not at extreme levels indicative of major market lows. In the Commentary section, we mention how it’s impractical for investors to make decisions around “Black Swan” events or geopolitical uncertainty.
Top Weekly Themes
- Equity Markets Continue to Move with the Russia/Ukraine Narrative – The tragic events surrounding the Russia/Ukraine conflict have clearly weighed on equity market prices. Stocks showed resilience during the first several days following Russia’s unprovoked attack of Ukraine but subsequently endured four days of consecutive losses. On Wednesday, March 8, headlines pertaining to a potential diplomatic solution brought down commodity prices, which have spiked dramatically in recent weeks, and helped ease investor concerns that the conflict will escalate further. We continue to believe that making wholesale changes from an asset allocation standpoint in response to geopolitical events is ill-advised given the myriad of potential outcomes. An example would be deploying a significant amount of capital to commodity-oriented investments after energy stocks have already risen over 30% thus far in 2022.
- Slower Growth Narrative is Likely Accelerating – In the past, we indicated that a combination of less fiscal stimulus, rising prices, and higher global interest rates would likely cause economic and corporate earnings growth to decelerate over the back half of 2022. The conflict between Russia and Ukraine is pulling forward our “slower growth” narrative timeline. The rapid increase in commodity prices are stoking fears about the impact on consumer spending. Based on research conducted by Piper Sandler, a 30% increase in gas prices alone would detract roughly 60 basis points (0.60%) from real consumer spending. At this time, we still believe that a mid-cycle slowdown is the most probable scenario given the strength of the labor market, an ample amount of household savings and cash on corporate balance sheets, the U.S. economy’s diminished sensitivity to oil prices compared to the late 1970’s/early 80’s, and the prospect of a more cautious Fed. As a result, we will be looking for opportunities to reduce our cyclical exposure and focus more on stable, growth stocks with less earnings and revenue variability.
- Credit Spreads Widen but are not Signifying Extreme Market Stress – Thus far in 2022, it’s been a challenging environment for riskier asset classes with most equity indices down double-digits. Equity market volatility often coincides with a dramatic spike in high yield corporate credit spreads. While high yield spreads have widened about 100 basis points (1%) since the beginning of this year, they have not reached levels indicative of extreme market stress. One factor could be that the energy sector is the largest issuer of high-yield bonds and this segment of the market has been a beneficiary of higher commodity prices. We will continue to closely follow credit markets, but do not envision making material asset allocation shifts within fixed income.
Returns Table
| Equities | Week(%) | YTD(%) | 1-Year(%) | 3-Year(%) | 5-Year(%) | Div Yield |
|---|---|---|---|---|---|---|
| S&P 500 | (2.4) | (10.0) | 11.9 | 17.96 | 14.65 | 1.40 |
| Russell 1000 Value | (1.7) | (4.7) | 9.7 | 12.34 | 9.27 | 1.97 |
| Russell 1000 Growth | (3.7) | (15.6) | 9.3 | 22.30 | 19.27 | 0.77 |
| Russell 2000 | (2.0) | (10.0) | (9.3) | 11.21 | 9.58 | 1.08 |
| MSCI EAFE | (3.2) | (11.6) | (3.7) | 6.86 | 6.50 | 2.86* |
| MSCI EM (Emerging Markets) | (6.6) | (11.3) | (15.2) | 4.62 | 6.17 | 2.55* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Div Yield |
| Bloomberg Barclays US Aggregate | (0.5) | (4.3) | (2.9) | 2.76 | 2.75 | 2.52 |
| Bloomberg Barclays US High Yield – Corporate | (1.3) | (4.9) | (0.2) | 5.02 | 4.86 | 6.03 |
| Bloomberg Barclays Municipal Bond | (1.0) | (3.9) | (2.1) | 2.78 | 3.24 | 2.04 |
| Bloomberg Barclays Global Aggregate x US (Country) | (1.3) | (4.7) | (6.9) | 0.99 | 2.24 | 1.47 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | (1.7) | 44.5 | 69.8 | 24.7 | 17.1 | 108.7 |
| Natural Gas (NYM $/mmbtu) Continuous | (4.7) | 28.2 | 69.2 | 16.8 | 8.9 | 4.6 |
| Gold NYMEX Near Term ($/ozt) | 3.4 | 8.7 | 15.7 | 15.3 | 10.6 | 1,985.9 |
| Copper Cash Official LME ($/mt) | (2.0) | 3.7 | 1300 | 16.2 | 12.2 | 10,052.0 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.11 | 1.14 | 1.19 | 1.12 | 1.06 | 1.10 |
| Japanese Yen per U.S. Dollar | 115.58 | 115.16 | 108.79 | 111.14 | 114.84 | 115.82 |
| U.S. Dollar per British Pounds | 1.33 | 1.35 | 1.39 | 1.30 | 1.22 | 1.32 |
Chart of the Week
Elevated VIX, But Not Extreme Pessimism
Takeaways:
- The chart above juxtaposes the S&P Index price level with the VIX (CBOE Volatility Index) going back to the early 1990’s. Dramatic spikes in the VIX (readings north of 40) are often indicative of major market lows and positive equity returns going forward.
- Investor sentiment has clearly turned negative as reflected in the Investor Intelligence Bull/Bear Survey from early March of this year. This was the first time since March of 2020 that the percentage of bearish investors exceeded their bullish counterparts. This is one of many contrarian indicators.
- We would like to see extremely pessimistic readings from multiple investor sentiment indicators before feeling reasonably confident that the market has reached its capitulation phase and the worst of this recent round of downside volatility is behind us. We have yet to see a the VIX spike over 40, a dramatic increase in Put/Call ratios based on CBOE data, and a series of inflated Arms Index readings (widespread selling on heavy trading volume).
Commentary
“Black Swan” Events and Investment Implications
Previously we mentioned that making investment decisions based on how geopolitical events unfold will likely lead to sub-par returns over the long run. First, one needs to accurately gauge the duration and severity of these events, and then determine how markets will react within a reasonable degree of precision. The chart below highlights various tumultuous developments over the past 70 years and how the S&P 500 performed over various time periods. Surprisingly, returns were positive most of the time over the subsequent 1-year period. Furthermore, historical events often reinforce pre-existing trends and typically do not impact the market over long periods of time.
We realize it can be quite unnerving when a leader from a nuclear-armed country ominously threatens members of NATO, and it’s tempting to stock up on overpriced potassium iodide pills (anti-radiation) and make wholesale changes to one’s portfolio. However, successful long-term investing requires that we do not become myopically focused on negative headlines involving geopolitical crises.
