April Showers Bring Flowers but Rain Still Sucks

Markets have quickly retreated this month off more hawkish US Federal Reserve comments regarding cutting rates and increased global tensions in current military conflicts. We have seen a correction of about 5.45% for the S&P 500 in the first few weeks of April falling through the infamous “5,000” level. 5% drops are very common and normal, but it is also very common once you exceed 5% the drop will continue to 8-10%.

Topics

Market Decline

US Federal Reserve Comments and Inflation

Global Conflicts (Israel/Gaza/Iran and Ukraine/Russia)

Market Decline

The S&P 500 is down about 5.45% as of April 19th, falling through the infamous “5,000” level. This has been a rapid decline after an incredible run to start the year. This has mostly been led by higher growth Technology and Semiconductor names. High valuations and high interest rates have taken their toll on these investments as investors must rethink if these areas can continue torrid pace in this new environment. With higher for longer rates companies with earnings that are further in the future are worth less than with low rates. The market is considering this scenario now as it re-rates many of these names.

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This drop has been led by the once unstoppable Nvidia, which has fallen 17% from its highs in March. Some other companies have followed suit with Apple, Microsoft, Netflix, Tesla, AMD, etc. with most down further than the market’s 5.45%. 

On the other side of the equation, there has been a rotation into value and inflation-led companies. Energy, Materials (Gold), and Utilities are up this month, which is especially interesting due to these companies normally perform better with lower interest rates. This does show investors are rotating out and there could be more potential for these sectors if interest rates were to decrease in the future and current trends persist.

US Federal Reserve Comments

In the US, inflation remains “sticky” and on top of this, their economy is humming along with jobs being plentiful. As a reminder, the Federal Reserve’s goals are to maintain low unemployment and control prices. Given employment remains strong and they do not have good control of prices, they are in no rush. This has resulted in interest rate cuts being less likely than before. The market has now reduced the potential rate cuts in the US down 1-2 times this year or about 0.50%.

While the Federal Reserve remains “data dependent” that information is not trending in the rate-cutting direction. There will need to be a change from the current trend to alter this. This would need to come in the form of lower inflation or an economic weakening. There could be inflation surprises if service spending does come down, there has been some indication from the restaurants reporting more difficulty on price increases. Travel companies are showing something similar but are still showing record demand. There are some cracks but not enough to bring inflation down to 2% quickly.

Global Conflicts

War what is it good for? Absolutely nothing. In the past week, there have been escalations in both major global conflicts. Iran sent 300 bombs directed at Israel and a few European nations commenting that they could get “more involved” in the Ukraine/Russia war. The Israel/Iran conflict appears to be calming down, but Israel/Gaza is not. This is putting pressure on the Red Sea transports and helps keep shipping inflation higher. The US has passed a war funding bill that will deliver more aid to Ukraine and Israel, this will keep the wars going with no clear end in sight.

This increase causes greater instability and higher protectionism. These two forces could push inflation higher and further government spending. The tension does create higher commodity prices and therefore higher input costs. While tensions are less than a week or two ago, one cannot ignore the risk to financial markets in this landscape. Last weekend when Iran attacked Israel demonstrated how quickly things can escalate and how focus can very quickly change.

Summary

Valuations and expectations have been too high, while you didn’t know what could bring valuations down it didn’t take much. A good portion of the market has been priced for “perfection” and a correction is well overdue. The S&P 500 dropping 3-5% is not uncommon but once the market goes 5%, commonly, it will continue to drop to 8-10% total. Given the valuations and headwinds of higher rates (and the disconnection from the US and the rest of the world), higher inflation, and global conflict this drop is warranted. Without employment dropping quickly or a Black Swan event there does appear to prolonged recession in the works. Countries can cut rates quickly and force all the money on the sidelines into the market at any time.

Justin, Konrad, and Merriel

More articles and information are available at www.knowprotectgrow.com 

Content Sources: Bloomberg, Trading Economics, Yahoo Finance, BCA Research

Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.

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