Gill Capital Partners Late-April Market Update
The wild ride in financial markets has continued over the past couple of weeks with equities revisiting March lows. We’ve seen financial markets attempt to digest a barrage of information including first quarter earnings season, a surprising GDP number, and continued geo-political risks. We will get into all of these, along with some high-level portfolio allocation changes we will be implementing in client portfolios due to changes and opportunities we see in the investment landscape.
Earnings Update
Earnings reports have picked up this week with several big technology companies rolling out first quarter earnings reports. So far, 42% of the S&P 500 companies have reported earnings, with 79% of those exceeding earnings estimates. Of the companies that have reported, revenue growth is up 11.5% and earnings are up 3.7% from a year ago. Both are well above estimates.
Our view – If you are looking for something positive to hang your hat on, here it is. U.S. corporate earnings continue to be strong. Yes, there have been some dramatic misses, like Netflix, but, overall, this is shaping up to be a very strong earnings season. Initially, many analysts were calling for an outright contraction in earnings growth, but we are certainly not seeing that. One big question coming into this earnings season was whether corporations would be able to manage around inflationary pressures and, so far, we are seeing margins hold up very nicely.
GDP Report
We received an initial read on Q1 GDP (Gross Domestic Product) this week, which showed a surprise contraction. The report showed that the U.S. economy fell at a 1.4% annualized rate in the first quarter, following 6.9% growth at the end of last year. The median projection by economists called for a 1% increase. On a year-over-year basis, the report showed that the economy still grew by 3.6%. This was the first quarterly decrease since spring of 2020.
Our view – On a quarterly basis, the GDP report can be volatile and subject to significant revisions. However, the Q1 report was a surprise, as most economists were anticipating positive growth in the first quarter, albeit more muted than in recent quarters. This report is complex, but the drop is largely due to a widening trade deficit in the first quarter, with U.S. imports increasing relative to exports. Looking deeper into the GDP report, robust consumer spending is still providing a backdrop for growth, but it is masked by inventory buildups and trade imbalances. Does this mean that the U.S. is already in a recession? No, not necessarily. While the risk of a recession is certainly increasing, we do not believe a recession is the likely outcome given the extremely tight labor market, good corporate earnings, and strong consumer spending. Remember, a recession, by definition, is two consecutive quarters of negative GDP growth, and most economists are forecasting positive GDP in the second quarter. Furthermore, a recent Wall Street Journal survey of economists calls for a 2.6% annual growth rate in 2022. While this forecast is well below last year’s 5.5% growth rate, it is still positive. Finally, the intricacies of what constitutes a recession are frankly not all that important, as the markets can exhibit extreme volatility irrespective of what we label it.
Geo-Political, Market Updates and Allocation Changes
Russia/Ukraine – Sadly, the situation in Ukraine continues to escalate, with a desperate Putin escalating the war of words and economics this week. His threatening language continues to raise anxiety levels, with pundits wondering what he is truly capable of. On the economic front, Russia shut off natural gas supplies to both Poland and Bulgaria as they refused to make payment in Russian Rubles. This energy blackmail will certainly have profound near-term consequences for these two nations that source the majority of their energy from Russia and are subsequently seeing skyrocketing energy prices. Other European countries, such as Germany and France, may not be far behind, which would create an even greater economic challenge for Europe and the Western world. European nations are now scrambling to find alternative energy sources, which will be difficult in the short term but will likely prove devastating to the Russian economy in the long term as European nations will seek to permanently shift away from Russian energy.
Chinese Covid Lockdowns – China has introduced lockdown measures in its two largest cities, Beijing and Shanghai, in a dramatic bid to stamp out Covid-19 outbreaks. Shanghai has been in a near-total lockdown for a couple of weeks, confining nearly all of its 25 million residents, as it continues to see upwards of 10,000 new cases per day. Beijing, while not under complete lockdown, fears the same fate is not far off as schools have been shuttered and mass testing exercises rolled out. China’s strict zero-Covid strategy seeks to aggressively stop the spread of the virus through mass testing, quarantines, and border closures. The arrival of the highly infectious Omicron has thrown this strategy into question as it is spreading faster than the Chinese can contain it. From a global economic perspective, this is once again putting pressure on global supply chains as ports, factories, and businesses have been closed.
Our view –It has become an increasingly complicated, confusing, and potentially concerning international environment. European economies are under significant pressure due to dramatically increasing energy prices and other effects of the Ukraine war, and China’s zero-Covid policy is aggravating an already tenuous global supply chain situation. For now, we have become much less constructive on the international growth outlook and environment and are looking to reduce our exposures to these areas (more on this below).
Market & Allocation Updates – The confluence of factors including inflation, the Russia-Ukraine war, the Chinese lockdown, higher interest rates, and economic slowing have contributed to a continued precarious market environment over the past couple of weeks. Equity markets remain volatile, re-testing the lows from March before rebounding sharply on positive earnings news. Bond yields have stopped their relentless push higher, at least for the time being, having priced in considerable Federal Reserve tightening to come.
Our view – Capital markets have certainly been on edge over the past couple of weeks but have seen some relief this week following positive earnings announcements and a respite from rising interest rates. As we mentioned above, we are making some changes within our recommended allocations. We have become more cautious on international equity markets and have decided to move from a neutral weighting to an underweight in this space. We simply see too many headwinds amidst a complex geo-political environment. On the fixed income front, interest rates have moved materially higher and we believe may be at or near terminal levels, at least in the near term. We are finally seeing attractive opportunities in fixed income. We have been materially underweight core fixed income for the past couple of years as the opportunity set has been relatively unattractive given historically low interest rates. This has been a good decision, but we are now moving closer to a market weight in fixed income as we believe reasonable returns can be achieved given higher interest rates and the potential for upside price movement from this asset class in the months ahead. We generally do not make frequent or dramatic changes within our portfolio construction, but these changes make sense to us given recent events coupled with significant changes in relative opportunities.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.