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A volatile first quarter comes to a close


The major U.S. averages ended near the flat line last week, moving less than 1% each. Stocks strung together a strong March rally, quickly looking past Russia/Ukraine war headlines and, more recently, a flattening yield curve. The S&P 500® Index returned +3.7% in March, its best month since December. But despite the more robust equity performance last month, most U.S. equity benchmarks finished the first quarter lower.

The S&P 500 Index ended the first quarter of the year lower by 4.6% on a total return basis. Likewise, the tech-heavy NASDAQ Composite finished Q1 down by 9.0%, while the value-centric Dow Jones Industrials Average lost 4.1%. For the S&P 500, the quarterly loss was the first since the depths of the pandemic in Q1’20.

Notably – though stocks generally trended lower over the first quarter on rising interest rates, expectations for more hawkish monetary policies, and increasing geopolitical threats – trading across major averages proved volatile throughout the quarter. After recording a record high on the first day of trading in January, the S&P 500 fell 13% to hit a closing low in early March, to then rally +11% from its closing low three days before quarter-end. It is pretty rare for the index to fall and rise by 10% or more in a single quarter. According to Bespoke Investment Group, the occurrence has only happened eleven other times in the post-WWII era. In all but three of those prior occurrences, the index closed the quarter lower, but returns over the next year were positive all eleven times, with a median gain of nearly +27%.1

Energy (+39.0%) posted its best quarter in history on surging oil prices, which rose more than +30% in Q1. Financials (down 1.5%) also outperformed the broader averages on increasing interest rates and outperformance from insurance companies, select regional banks, and credit card providers. Sector laggards in Q1 included Communication Services (down 12.0%), Consumer Discretionary (down 9.0%), and Information Technology (down 8.4%). These growth-based sectors experienced headwinds throughout Q1 from rising rates, waning investor confidence, valuation concerns, and company-specific earnings misses.

With expectations of aggressive Fed rate tightening this year, U.S. Treasuries sold off sharply in Q1, as the 2-year yield climbed roughly 230 basis points while the 10-year yield rose over 80 basis points. The U.S. dollar rose +2.5%, gold gained nearly +7.0%, and the broader commodity complex rallied roughly +30%.

Alternative Strategies helped reduce both equity and fixed income volatility during the quarter. Strategies dedicated to Equity Market Neutral, Multistrategy, and Nontraditional Bond posted solid results.

On Friday, the Bureau of Labor Statistics released the March nonfarm payrolls report, which showed job growth rising by +431K. In addition, the unemployment rate sank to 3.6% and is now just a tick above the 3.5% level seen in February 2020 and before the onset of the pandemic.

In addition, job growth in January and February was revised higher by +95K. The U.S. economy has created more than half a million jobs on average this year, which is on par with last year's pace. Bottom line: The labor market is strong and adds a solid fundamental layer of support for stock prices, in our view. Notably, average hourly earnings climbed +0.4% m/m in March and are higher by +5.6% year over year. We expect the Federal Reserve to closely watch wage growth trends moving forward as it determines the shape of rate policy and keeps tabs on whether inflation pressures become unanchored. We expect average hourly earnings growth to moderate in the coming months, which could help quell concerns that inflation pressures are swirling out of control. We believe stocks could eventually react more favorably to developments that show that wage inflation is moderating, implying that Fed rate hikes won’t need to be as aggressive as currently feared.

Yield curve inversions

Outside of quarter-end results and the March payrolls report, investors spent last week monitoring yield curve trends, or more directly, “inversions” across the U.S. Treasury curve. Yield curve inversions are rare and occur when shorter-term bond yields are higher than longer-term bond yields. Typically, investors expect to receive higher yields on their investment the longer they tie up their money. But when shorter-term rates outyield longer rates, it is often a sign of unusual market circumstances (e.g. growing recession concerns) or, in the current case, a rapid change in monetary policy expectations.

While there are several points across the Treasury curve to monitor, headlines last week focused on 5-year rates outyielding 30-year rates and, most notably, the 2-year Treasury outyielding the 10-year Treasury. While each moved in and out of inversion during the week, investors' recession radar was raised. And while investors shouldn’t ignore the warning signs the yield curve is flashing today, they also shouldn’t make any predetermined assumptions about future growth or portfolio positioning. In our view, monetary policies remain highly accommodative today, even considering the likely moves higher in rates this year. So, for now, investors should discount the inversion headlines and focus on the still solid economic/corporate backdrop, which could eventually lead to more favorable stock trends this year.

As the second quarter gets underway, still oversold stock conditions and weak investor/consumer sentiment offer contrarian buying opportunities for investors with the patience and willingness to look through near-term volatility. However, continued economic normalization, improving COVID-19 trends in the U.S., and strong consumer/business balance sheets are other factors that also support a still favorable view on market returns this year. And if analysts prove too conservative with their Q1 profit estimates, stocks could see some upside momentum through the earnings season, as higher sales and strong pricing power help companies protect elevated profit margins. Finally, we would also suggest the market is currently pricing in ultra-aggressive Fed rate hikes this year, which could eventually offer a tailwind for asset prices if not fully realized.

Looking ahead this week, the economic calendar focuses on final February durable/factory orders, March auto sales, final looks at March PMI/ISM data, last month’s FOMC meeting minutes, and initial jobless claims. Investors will also keep a close eye on interest rate moves, ongoing developments in the yield curve, and moves across commodity prices. Importantly, crude prices have come down considerably over recent weeks and since spiking higher on Russia’s invasion of Ukraine. In our view, declining crude prices as of late (partly driven by the White House’s decision to tap U.S. strategic reserves) have helped quell the more aggressive fears of runaway inflation. Consequently, lower oil prices have helped stocks bounce off their mid-March lows.

Important Disclosures:

1 “B.I.G. Tips – Roller Coaster Quarters and April Seasonality,” Bespoke Investment Group, March 31, 2022

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