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Can equities deliver solid gains in the second half of the year?

Despite an expected growth slowdown, there is a bull case for stocks.

Our Top Market Takeaways for April 22, 2022.

Market update

Are you still watching?

It was another volatile week on Wall Street, but don’t let Thursday’s sell-off get you too despondent. Eight of the 11 S&P 500 sectors are in the green this week, with cyclical sectors such as financials and industrials (both +1%) among the best performers.

There isn’t much new to mention on the macro front. The war in Ukraine is still causing uncertainty, and central banks are still planning to raise rates aggressively. At an IMF panel on Thursday, Federal Reserve Chair Jerome Powell seemingly endorsed using 50-basis-point rate hikes in order to more quickly to get the policy interest rate back to what the Fed thinks is a more “neutral” stance. Yields across the spectrum in both the United States and Germany are trading near cycle highs.

However, there are some interesting tea leaves to read in the micro of corporate earnings reports.

On the encouraging side, airlines have reported stellar results stemming from pent-up demand from both corporate and leisure travelers, as well as strong pricing power. Banks are seeing strong loan growth and resilient credit quality. Tesla, the fifth-largest stock in the S&P 500, exceeded estimates and was one of the few stocks to post positive gains on Thursday. Overall, corporate management teams may be a little bit more conservative than they were at the end of last year, but they still seem quite upbeat about forward-looking demand and earnings prospects…

…unless you are Netflix. The streaming pioneer lost a staggering $50 billion of market value in just one trading day after reporting a loss of subscribers for the first time since it sent DVDs in the mail. The stock has now lost 70% over a five-month period for the third time in its history. The weakness bled to other companies even tangentially related to online engagement: This week, Spotify lost 16%, Peloton lost 14%, DraftKings lost 10%, Roku lost 8% and Disney lost 5%.

So far this earnings season, the divide between the digital world that thrived during the pandemic and the physical world that has years of catching up to do is becoming very apparent. This is one reason why we don’t think investors should be too worried about a growth slowdown through the rest of this year. In fact, there is a decent bull case to be made.


The bull case

Don’t throw the towel in just yet. Most of our focus over the last few weeks has centered on the growth slowdown we think is coming, and making sure portfolios are positioned for it. High-quality equities and investment-grade fixed income have been in focus.

But how could things go better than expected? There is a decent bull case to be made, which could be all the more impactful given that retail investor sentiment is still fragile and positioning is far from stretched. For example, the latest AAII Bull-Bear reading came in at -32.6. For context, since the AAII series began, we have only seen 12 prints that suggested this much pessimism from retail investors. Interestingly, six and 12 months after such pessimistic readings, the S&P 500 has recorded average gains of 8% and 17%, respectively.

While we do expect a growth slowdown through the second half of the year, we still expect equities to deliver solid gains. Here are a few reasons why.

1. Growth is holding up admirably, given the headwinds. The Atlanta Federal Reserve GDPNow tracker suggests that first-quarter real GDP will come in at just a 1.3% pace, but most of the weakness comes from trade and inventory building. Final domestic demand (which excludes inventories and trade) is tracking at a much more robust 4%. Add on another ~3.8% from inflation, and you get a nominal growth rate for domestic demand of ~8%. While that pace should slow as we move into the second half of the year, it should still be supportive of trend to slightly above trend corporate earnings growth. Even though the housing market is likely to cool, given the sharp rise in mortgage rates, new construction is still solid. Perhaps the most encouraging data is that multi-family construction is hitting new cycle highs. This is important because the country has a housing shortage. More apartments could help to alleviate rental inflation, even if it takes some time for them to come on line. The housing market should cool, but it probably won’t collapse.

2. Inflation could start surprising to the downside. Last week, we discussed the latest CPI report and how the details suggested some welcome cooling of inflation. Since then, we have more indications of similar trends. The Federal Reserve’s Beige Book hinted that wage growth was starting to slow. The early release of the Manheim Used Vehicle Value Index suggests that used car prices are still falling, and shipping rates are at their lowest levels since last summer. The Philadelphia Fed’s Manufacturing New Orders Index hit its lowest levels since the Global Financial Crisis, and the latest estimates from Zillow suggest the worst acceleration in rental inflation is behind us. If inflation does start to surprise to the downside, it could give the Fed leeway to adjust its rate-hiking plans in the second half of this year.

3. Corporations are still confident. If corporations are confident in their outlooks, it seems likely they will continue to hire and invest in new capacity even if they might downshift because of higher interest rates. This results in stronger earnings for consumers and more revenues for other corporations. In that sense, a strong economy begets a strong economy. Dubravko Lakos-Bujas of the Equity Strategy Team in our Investment Bank published a report on overall corporate commentary and found that “geopolitical tensions remain a key source of negative sentiment along with strengthening [U.S. dollar], rising input costs including commodity prices, and higher rates. However, some improvements in sentiment are seen around supply chains, labor market, [and] COVID, while general sentiment around consumer and investment activity remains healthy.” Data from the Business Roundtable CEO Economic Outlook survey and the NFIB Small Business survey also suggest robust CAPEX and hiring intentions. Growth may slow, but it doesn’t seem likely to stall soon.

Investment takeaway

The market might be getting a little less anxious

It is clear that sentiment is fragile and that markets are likely to remain volatile in the near term. However, there are a few signs that markets are getting a bit more comfortable with the current environment. Currently, 75 S&P 500 stocks are trading near 52-week highs, while 15 are trading at 52-week lows. The stocks making new highs represent an interesting mix of companies, from AutoZone and O’Reilly to Ulta Beauty, to Hilton and Marriott Hotels, to Anthem Insurance and Bristol Myers Squibb, and a bunch of energy- and food-related companies that are benefiting from higher commodity prices. The stocks making new lows include PayPal, Meta and Netflix—pandemic-era darlings that benefited from social distancing.

The bond market is also getting less worried about the Fed making a mistake. The 2s10s curve has steepened back out to positive territory because the market is pricing in fewer cuts in the back half of 2023 and beyond. Just two weeks ago, SOFR futures implied that short rates would move back down to 2.5% from over 3%. Now the same market suggests short rates will only move back down to 2.75%. Fewer cuts are good signs because they imply a higher probability that the Fed can raise interest rates without having to cut them right away because they went too far.

While it appears likely that growth will slow down from the booming pace of 2021, we don’t think excessive concern is warranted either. It just seems that markets are adjusting to a post-COVID-19 economy characterized by less policy support and more real-world interactions and commerce.

Just as in life, balance will be key to investors for the rest of the year.

All market and economic data as of April 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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All market and economic data as of April 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

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