Telemus Weekly Market Review April 25th - April 29th, 2022
This past week the Bureau of Economic Research announced that the U.S. economy contracted by -1.4% in the first quarter. The surprise deceleration, alongside rising concerns around the ability for companies to maintain their level of profit margins began to weigh on investor sentiment. A sizable drop on Friday, where the S&P 500 fell by -3.6%, led to a down week where the S&P 500 lost -3.3%.
The release of the 1st quarter Gross Domestic Product (GDP) showed a surprising decline in economic activity. The key factor driving the softness was a reduction of inventories, which followed an exceptionally strong fourth quarter 2021 when inventories rose at a stronger rate than expected. Inventories can be unpredictable and supply chain challenges add to the volatility. Thus, one has to consider the -1.4% decline in 1st quarter GDP alongside a better than forecast +6.9% rise in the 4th quarter of last year. Aside from the drawdown in inventories and another record setting trade deficit, healthy consumer spending and positive business investment demonstrated resilience for a bulk of the quarter’s economic activity.
Aside from the first quarter GDP report, this week’s news flow centered around first quarter earnings reports. This was the busiest week for S&P 500 companies to report earnings, with the large technology stalwarts all reporting. While in aggregate earnings results have been strong, we’ve begun to see some companies warn of softness on the horizon, a tone that only excites investors concerned with prospect of potential margin pressures.
We do see risks to margins. Corporate profit margins are at peak levels, well ahead of previous peaks experienced before the pandemic (see the chart below). Companies continue to grapple with staffing challenges, which will inevitably impact productivity. In addition, with inflation elevated there is no certainty that companies will be able to pass cost pressures along without impacting sales volumes. As such, it’s not unreasonable to assume margins compress to some degree during the back half of 2022.
This week’s GDP data provided evidence that consumers are shifting their behavior away from goods back toward services. Based on the data provided by the Bureau of Economic Research, consumers consumption of goods has expanded by 17% since 2019, while spending on services is down nearly 4%. As spending patterns return to normality, we’d expect purchases of goods, particularly large ticket items, to ease in favor or more spending on services such as travel, entertainment and even healthcare. A broader recognition of this transition resulted in the consumer discretionary sector falling nearly -8% this past week, making it the weakest sector in the S&P 500.
Looking ahead, the market’s attention will be on the Federal Reserve which meets on Tuesday and Wednesday. It’s a foregone conclusion that the Fed will increase the overnight federal funds rate by at least a half a percent, with odds of a three-quarter point increase on the rise. One area of uncertainty will be on whether the Fed begins to reduce its balance sheet immediately or hold off on starting the so called ‘quantitative tightening’ process until its meeting in June.
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