April Outlook: Fed Rate Hikes, Russian Invasion, And The Uncertainty They Cause

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Investors hardly know where to turn in recent sessions as a myriad of political, economic, and health issues continue to bombard them every day.

Growing tensions and casualties tied to Russia’s invasion of Ukraine, worldwide sanctions against Russia, Federal Reserve interest rates, rising oil prices, supply-chain holdups, new COVID-19 variants, and new COVID-19 lockdowns—they’re all having an impact.

The markets ricochet right along with headlines: Up one day, plunging the next, recouping losses the third day, rinse and repeat. Market pundits call a bottom only to have others say it’s too early. Technology stocks are in favor one day, down the next. Consumer discretionary stocks look like a sure thing, until they don’t.

The first quarter was a rocky one, starting and ending in the red for all three major indexes. Though March’s final day of trading ended in a big dip for the Dow Jones Industrials ($DJI), S&P 500 (SPX), and the Nasdaq ($COMP)—all finished about 1.5% or slightly deeper—it was the first month to the upside.

That doesn’t mean all losses were recovered, but each marked notable gains: The Dow is up more than 4%, the S&P is up more than 5%, and the Nasdaq is ahead 5% for the month.

There’s little question the economy is going to slow down, and that is the Federal Reserve’s goal. But slow doesn’t always equate to stoppage. The economy has been mostly on an aggressive growth path, shaking off the pandemic as if much of it never happened. High single- and low double-digit advances may come to an end, but even low single-digit growth is still, yes, growth.

Long-time investors know that this too will pass, but those new to the nuances of trading are likely holding on—white-knuckled and probably a little sweaty—as they try to figure out what to do next.

Stay calm. That’s always the mantra for the rockiest of times. There will be buying opportunities, but there also could be head-fakes, so investors are warned time and again to keep a cool head, diversify their portfolios and, many times, just wait.

Fed Rates

Anyone who pays the slightest bit of attention to Fedspeak knows the Federal Reserve is on a warpath to lift rates to 2.75% by 2023. Inflation is off the charts, and raising rates is the best tool the Fed has to put the brakes on the U.S. economy. Higher rates are expected to slow down spending, or demand, as supply catches up.

But investors are debating how fast this might happen and what kind of impact it might actually have. Remember, the federal funds rate is still at super low levels, 0.25% to 0.5%, and even six or seven rates increases this year will still leave the rate at historical trough levels.

The Fed looks to get to a “neutral” rate, which is roughly 2.4%. At that level, the Fed believes it won’t boost growth or hinder the economy but could help rebalance it. The question bouncing around investor chats these days is if a 2.75% level is enough to get there without triggering a recession.

Unemployment sits at 3.6%, below what’s considered a “natural” rate. The growth in wages suggests the labor market is very tight. However, unemployment rates traditionally tend to edge up when the Fed raises rates.

And then there’s this: How much of this inflation was the Fed ever in control of? By most measures, it was the pandemic, the lockdowns, the supply-chain disruptions, the pent-up demand and built-up reserves from consumers, and the stimulus checks that created much of the quagmire we’re now in. The Fed didn’t have a hand in any of that, though it did keep interest rates low as the situation unfolded, which many see as the real catalyst to staggering inflation.

That puts the Fed in a conundrum: It wants to slow down growth, not kill it. Many Fed watchers believe the group’s pivot to “catch up,” as it were, to a more neutral rate, or the 2.75% that’s on the books now, will give the Fed the wiggle room it needs should the economy go in the wrong direction. Others think it will push the economy into a recession.

And there are those who believe if the Fed dramatically pushes rates higher to, say, a 5% level, that will lead to the so-called “soft landing” everyone wants. Time will tell.

From a stock perspective, Fed rate hikes are historically the best time to invest. But as we’ve been reminded throughout the choppy volatility that marked the markets in March, past performance is no indication of future results.

Yield Curve Signs

The 2-year and 10-year yield curves did, as expected, invert after weeks of close scrutiny and bets that it would. Why does that matter? A flattening curve typically signals what we already know: Rate hikes are in the works and a recession might be lurking.

Recessions don’t typically happen the next week or even the next month. It can take six months, a year, even two years.

But remember this: Yield-curve inversions have led to every recession since 1955, according to a 2018 Federal Bank of San Francisco report. Only once did it not. But—and this is a big but—there has never been an environment like this that includes a war, a pandemic, and a stock market still mostly in rally mode.

For example, the yield curve last inverted in 2019, and we did have a recession in 2020. But who knew in 2019 the pandemic was going to be the catalyst?

The economy is going to slow—from where it was and where it is. But slow doesn’t always equate to no growth. While bonds flash a bearish signal, it is earnings results and future guidance that could give us the best indicator for this environment.

Spring Housing Shift

The early moves into the spring housing markets have been sluggish, suggesting a full-year slowdown tied to a host of factors, including the double whammy of rising interest rates and escalating home prices, partially driven by the limited supply of existing homes and labor shortages for new homebuilding.

Existing monthly home sales tumbled 7.2% in February, the latest numbers available, falling for the fourth-straight month, according to the National Association of Realtors (NAR). On a year-over-year basis, sales slumped 2.4%.

Spiking mortgage rates are further complicating the issue. The average 30-year fixed mortgage rate has been on a relatively sharp incline since December. Standing at 4.56%, as of Monday, the rate is more than a full percentage point higher than it was a year ago, according to Freddie Mac.

Now pit that against the rising cost of staking your home base. In February, the median existing-home price jumped 15% on a year-over-year basis, according to NAR. At 120 consecutive months—that’s dating back 10 years—it marked the longest-running streak of rising prices on record. A mortgage applicant’s median principal and interest payment in February jumped $127 over the month before and $337 from the year-ago period, according to the Mortgage Bankers Association.

Given all that, it’s likely the dynamics of the housing industry could shift as some potential buyers get priced out and some sellers might find themselves slashing prices.

It also might help investors understand why housing-related stocks have gotten crushed. Is it mortgage prices? Supply-and-demand issues? Labor and materials issues? Or all of the above?

Tough to tell, but numbers don’t lie. D.H.Horton (DH) has tanked deeper than 29% since the beginning of the year, PulteGroup (PHM) shares have dropped 25%, Lennar (LEN) shares have given back more than 27%, Hovnanian (HOV) shares plunged 38%, and Toll Brothers (TOL) shares slumped 23%.

 

Earnings results and the forecasts management offers could be telling of how the industry is handling the shifts.

What Earnings Tell Us

Like much of the first quarter, earnings expectations have been tempered as the war in Ukraine has turned over nearly every apple cart. Couple that with inflation at decade highs, and it’s hard to imagine consumer discretionary spending isn’t going to shift as folks pay more for daily staples, such as food and fuel.

As of late last week, analysts pulled down the S&P 500’s estimated earnings growth rate to a cumulative 4.8% for the first quarter, according to FactSet. That’s fallen from a 5.7% forecast at the start of the quarter as companies and analysts have yanked their expectations since December 31.

So far, 66 of the 95 companies on the index that have issued guidance are to the downside. That put the percentage of companies with negative EPS guidance for the quarter at 69%, notably below the 60% five-year average, according to FactSet. It’s likely too that we’ll see more of this as analysts lower the bar to better reflect the decelerating trends from the highs of the last few years.

Downward revisions have hit seven sectors, led by the industrials, consumer discretionary, and communication services, according to FactSet. Not surprisingly, energy has headed upward, leading the four sectors that have seen better projections since the price per barrel of oil has shot up. But, as FactSet noted, few energy companies have provided quarterly guidance, so the numbers could be skewed. Same for financials, which is expected to post better results tied to interest rates.

At the sector level, supply-chain issues are hampering the industrials and information technology sectors, which have seen the biggest jumps in negative EPS guidance for the quarter.

How Bad Is It?

Earnings are a lagging indicator of what already has happened; forecasts are a peek into what may or may not happen. Investors are likely to be listening to what happened in the quarter and how did management, well, manage it, plus what the outlook is in an environment of so much uncertainty.

Efficiency could be the key to identifying good, better, and best-managed companies as earnings unfold. Commodities across the board have surged, and there’s nothing any company can do about that. It’s how they coped with all those changes that will matter, and the results should show it.

And then there’s the outlook. Guidance could be quirky. In its most simple formula, management looks at what’s in front of it, inputs what it thinks may or may not happen down the road, adds how it can adjust costs to better fit expected revenue streams, and puts its best guess out there for investors to digest.

Sometimes, managers will low-ball prospects to provide a cushion or to look like superstars when they handily beat expectations.

RH, formerly known as Restoration Hardware, Chief Executive Gary Friedman put things into perspective with his company’s conservative guidance, speaking at length and candidly on the conference call about the challenges his high-end home furnishings firm faces.

“It’s probably one of the most difficult guides since 2008 and 2009 because…we’re right in the middle of this disruption from Ukraine and Russia. I think it’s triggered a greater awareness,” he said, referencing a sudden pullback in customer demand.

“It just became a kind of reckoning point, if you will, where people had to stop and pay attention to everything,” he said. “When it returns to ‘normal,’ I’m not sure. How aggressive is the Fed going to be? Not sure.

“I don’t mean to be a pessimist, but history would tell us, four or fives times the Fed raises rates over a sustained period, we have a recession,” he added.

That’s a lot of rarely heard doom-and-gloom coming out of a conference call, but it does underscore the ambiguity this unprecedented period in history represents for companies of all shapes and sizes.

However, one comment Friedman made more than once might also offer a pulse on what’s ahead, imperfect as it might be: “In my 22 years, I’ve never been more excited, and I’ve never been more uncertain.”

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image sourced from Unsplash

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.