(Clark Capital) After a brief reprieve in March, stocks tumbled further in April with declines coming across the equity markets. The weakness in April added to already negative returns from the first quarter of 2022, which was the first down quarter for stocks in two years. Growth stocks, both large-caps and small-caps, were particularly hard hit with double-digit declines for the month. Large-cap stocks did marginally better than small-caps in relative terms in April, but the story was more about style with growth stocks leading the market lower. The CBOE Volatility Index, or VIX Index, rose for much of April and closed at 33.40, which marked one of the highest closing levels of 2022 – therefore one of the highest closing levels seen in over a year. The VIX Index ended March at 20.56, so the move higher in April was pronounced as volatility reigned for much of the month. Our expectation of more volatility as we moved into 2022 has occurred as the Omicron variant continued early in the year, followed by the crisis in Ukraine, and culminating with the beginning of the Fed rate tightening cycle in March and ongoing hawkish talk by some Fed officials. These issues, along with the ongoing backdrop of high inflation, have kept markets choppier to start 2022.
Size and style continue to matter in terms of relative performance. We still believe that the value/growth disparity that reached a peak in 2020 will likely continue to shift as we move into 2022 with value improving on a relative basis. That has proved to be the case so far this year. We at Clark Capital continue to use our disciplined approach of seeking out what we believe are high-quality companies with improving business conditions at good prices.
The numbers for April were as follows: The S&P 500 fell -8.72%, the Dow Jones Industrial Average slid by -4.82%, the Russell 3000 declined -8.97%, the NASDAQ Composite tumbled -13.24%, and the Russell 2000 Index, a measure of small-cap stocks, dropped -9.91%. For the first four months of 2022, the returns in the same order were as follows: -12.92%, -8.73%, -13.78%, -21.00%, and -16.69%.
Overall, for the quarter, value clearly outperformed growth on a relative basis. Looking closer at style, the Russell 1000 Index fell -8.91% for the month. The Russell 1000 Growth Index declined -12.08%, while the Russell 1000 Value Index dropped -5.64% in April. For the first four months of the year, the Russell 1000 Growth Index dropped -20.03%, compared to its value counterpart off -6.34%.
The same trend held for small-caps from a style perspective, but with larger overall declines as small-caps underperformed large-caps for the month and year to date. The Russell 2000 Value Index fell -7.76%, while the Russell 2000 Growth Index declined -12.27% in April. Year to date, those two indices are down -9.97% and -23.35%, respectively. International stocks had an equally challenging month with declines recorded throughout most global markets. The MSCI Emerging Markets Index fell -5.56% in April and was off by -12.15% year to date. As would be expected with the Russian invasion of Ukraine, emerging Eastern European stocks have been the worst regional area this year. The MSCI ACWI ex USA Index, a broad measure of international equities, fell -6.28% for the month, and is down -11.38% so far this year.
Fixed Income
The yield on the 10-year U.S. Treasury moved higher again in April as the historically weak start to the year for bonds continued. Most bond sectors came under pressure as the resetting of interest rates across the board led to further declines in bond prices. The 10-year U.S. Treasury yield closed March at 2.32% and it ended April at 2.89%.
The rise in interest rates put pressure on bond prices and most segments of the bond market declined for a fourth month in a row – in some cases with April being the worst month so far this year. Fixed income returns were as follows for April: the Bloomberg U.S. Aggregate Bond Index fell -3.79%, the Bloomberg U.S. Credit Index slipped -5.24%, the Bloomberg U.S. Corporate High Yield Index declined -3.56% and the Bloomberg Municipal Index dropped by -2.77%. The 30-year U.S. Treasury Index slid a remarkable -10.25% for the month and the general U.S. Treasury Index declined -3.10%. For the first four months of 2022, the returns for these indices in the same order were as follows: -9.50%, -12.27, -8.22%, -8.82%, -20.49%, and -8.50%.
Clearly, this has been an unprecedented start to the year for bonds. Recall that in 2021, the Bloomberg U.S. Aggregate Bond Index recorded only its fourth annual decline since its inception in 1976 – and the worst year on record for the Agg was 1994 when it declined -2.92%. Last year was a challenging year for investment grade bonds, and particularly for U.S. Treasuries, as yields moved higher. Unfortunately, that trend has continued into 2022 and broadened to other bond sectors as the market is trying to price in how aggressive the Fed will be in this rate-hike cycle. We maintain our long-standing position favoring credit versus pure rate exposure in this interest rate environment. We also believe that the role bonds play in a portfolio, to provide stable cash flow and to help offset the volatility of stocks in the long run, has not changed.
Economic Data and Outlook
The strength in job market data continued in March, despite payroll numbers falling short of expectations. Non-farm payroll additions were expected to be 490,000 in March, when 431,000 job gains were reported. However, February’s already strong reading of 678,000 job additions was revised higher to 750,000. Furthermore, the unemployment rate dropped to 3.6% in March compared to the prior month’s mark of 3.8% and expectations of 3.7%.
The Omicron surge early in the year does not seem to have hindered hiring in the first quarter. The labor force participation rate went up modestly as expected to 62.4% in March from 62.3%. Over 11.2 million open positions were reported in February, which was ahead of the 11 million estimate. There are still millions more jobs available than those searching for work, so this mismatch in the labor market continues. However, job gains were strong in the first quarter and more people moved back into the labor force. Ultimately, the job market is important to track with about 70% of U.S. economic activity driven by consumer spending.
The housing market is still posting strong numbers, but as mortgage rates surge higher (as interest rates move higher) this will be an important part of the economy to monitor. Strong demand and low inventories have resulted in home prices that continue to rise dramatically. Based on the year-over year reading of the S&P CoreLogic CS 20-City Index, home prices increased by a more than expected 20.2% in February, which was the third month in a row that home prices have risen at a faster rate than the prior month.
Housing starts and building permits were above estimates in March and both exceeded February’s levels. New home sales fell short of expectations and declined from the prior month. Existing home sales might be seeing the impact of higher mortgage rates as they dropped for a second straight month to an annualized pace of 5.77 million in March from a revised 5.93 million pace in February. Often, during times when interest rates rise sharply, home purchases can initially increase as buyers want to lock in a mortgage and a home before rates go even higher. This played out with existing home sales surging in January, but dropping notably in February and March. The housing market has been, and continues to be, a source of strength in the economy, and has historically been a good leading indicator as well. The impact of higher mortgage rates will be important to follow in the months ahead.
The ISM Manufacturing Index for March declined from the prior month to 57.1, which was also below expectations of 59.0. The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, increased to 58.3 from 56.5, but it too fell short of expectations. Manufacturing and service industries are still showing strong levels of growth, but following the recent trend, some moderation in the pace of growth has occurred. Recall that ISM readings above 50 indicate expansion and below 50 signal contraction, so these current readings remain in very strong growth territory.
Retail sales (ex. auto and gas) rose by 0.2% in March as expected. February’s reading saw a large revision from a previously reported decline of -0.4% to a gain of 1.3%. It is important to note that higher prices, meaning inflation, can be a significant factor for this reading as the retail sales data is not inflation adjusted.
Consumer confidence, based on the preliminary University of Michigan Sentiment reading for April, made an unexpected gain to 65.7 compared to the prior reading of 59.4 and expectations of 59.0. Concerns about inflation, pandemic issues and geopolitical risks with Russia and Ukraine are weighing on consumer sentiment, but the stock market rebound in March and ongoing strength in labor conditions likely helped this latest reading.
The Conference Board’s Leading Index rose as expected by 0.3% in March and February’s previously reported 0.3% gain was revised to show a 0.6% advance. The first or advance reading of Q1 2022 GDP showed an unexpected drop in economic activity by a -1.4% annualized rate when a 1.0% gain was expected. However, some unique circumstances were reflected in this report including a surge in imports, which resulted in a trade deficit subtracting 3.2 percentage points from the GDP number. Personal spending remained solid, increasing by 2.7% on an annualized basis. Recall, GDP in the fourth quarter of 2021 was exceptionally strong at a 6.9% annualized growth rate. We at Clark Capital are expecting GDP growth to be 3%+ in 2022 – still above trend economic growth, but slower than the growth enjoyed in 2021.
Inflation has been problematic for the Fed while the job market recovery has been strong. The Fed has clearly shifted its focus from the full employment side of its mandate to price stability as we began a rate-hike cycle in March. Inflation has surged to generational highs. The headline Consumer Price Index (CPI) rose by 8.5% on a year-over-year headline basis in March – the largest annual increase since the early 1980s – and 6.5% on a core basis, which excludes food and energy prices.
The headline Producer Price Index (PPI) reflected another double-digit annual gain by rising 11.2% in March, which surpassed even lofty expectations of 10.6%. Inflation will likely remain elevated well into 2022, but we anticipate it will moderate as the year progresses. The Fed has clearly signaled to the market that inflation is its focus and it does not want higher inflation expectations to become rooted in our economy.
We remain resolute in our belief that the U.S. economy and corporate America will continue to recover as we progress beyond the pandemic. The Omicron spike we saw early in the year has improved, although another subvariant has been making recent gains. The U.S. seems to be moving toward treating the coronavirus as an endemic versus a pandemic and not letting it be as disruptive to our daily lives. Looking beyond the humanitarian aspect of the Russian invasion of Ukraine, we do not believe the invasion will have much of an impact on earnings, which are the primary driver of stock prices over the long run. However, since we are still in the early stages of this event, we will need to monitor how widespread this situation becomes.
We are transitioning away from the stimulus fueled economy to a Fed that will continue to raise rates from the foreseeable future. This will likely usher in more market volatility than has been experienced since the pandemic began. However, we believe fundamentals still look solid and our expectations for 2022 of 3%+ GDP growth and high single digit earnings growth remain. We believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market derail them from their longer-term objectives.
Investment Implications
Clark Capital’s Top-Down, Quantitative Strategies
The market entered May tactically oversold, with the Technology and Consumer Discretionary sectors at the heart of the selling pressure.
We continue to manage risk across the tactical portfolios by limiting beta. Our Fixed Income Total Return and Global Tactical portfolios remain defensively positioned with 50% of the portfolios holding cash equivalents.
Clark Capital’s Bottom-Up, Fundamental Strategies
The Nasdaq composite posted its worst monthly performance since the start of the pandemic, declining more than 13.0%, as Technology companies have taken the brunt of the selling pressure due weaker than expected first quarter earnings and higher interest rates.
The Federal Reserve has shifted from dovish, patient and jawboning to hawkish and aggressive. Expectations of rate hikes have increased with several 0.50% hikes priced into expectations. Across our bottom-up equity portfolios, we continue to shift portfolios away from beta, duration, fragility, and labor intensity.
