Rising geopolitical risks, inflation, and interest rates have continued to cause challenges for investors across equity and fixed income markets. KAR CIO Doug Foreman, CFA, puts recent market events into longer-term perspective. Webcast recorded on May 4, 2022.

Related Commentary: Macro Events Dominate April Headlines

April proved to be an extremely challenging month across markets and was dominated by macro headline events, such as higher inflation, the continuation of global supply chain issues, the Fed’s rate increases, and the war in Ukraine. Taken together, these macro events created negative pressure on stocks and bonds, pushing some markets into correction territory and others into bear markets.

For the year to date through April, the energy and utilities sectors posted the strongest returns, while other, more economically sensitive, sectors lagged. While growth has experienced a long period of outperformance (since the Global Financial Crisis of 2008), value has outperformed growth as more capital-intensive and defensive stocks, such as certain commodities, utilities, and economically insensitive areas such as insurance and big pharma, benefited from the spike in commodity prices. Growth stocks, on the other hand, led by high exposure to technology companies, lagged. Time will tell if value stocks outperforming will become a sustainable trend.

As far as market sentiment, the current environment is defined by investor fear and selling. By historical measures, when so many investors are feeling fearful, our view is that this fear has been a reliable indicator of an attractive entry point into the market, notwithstanding some additional negative macro news headlines and volatility. For investors concerned about the possibility of a recession, we believe it is important to watch the 2-year U.S. Treasury rate, which went from about 30 basis points (0.30%) in late October to 2.69% at the end of April. The rate started climbing in February when the Fed decided that inflation was no longer transitory but more structural in nature. At that point, the Fed became more aggressive in telegraphing the need for a series of rate increases sooner rather than later, which moved yields higher.

Figure 1: U.S. Treasury Yield Curve

U.S. Treasury Yield Curve Chart for 4/30/22, 12/31/21 and 12/31/20

Source: FactSet, Federal Reserve. Data as of April 30, 2022. Forecasts are not a reliable indicator of future performance. Positive yield does not imply positive return. Past performance is no guarantee of future results.

While the market has already anticipated and priced in the Fed rate increases, the yield curve remains flat (Figure 1), which tells us the economy may be slowing. Typically, the yield curve would need to invert (an inversion is typically defined as long-term yields dropping below short-term yields) and stay inverted over an extended period to be considered a tool to forecast a recession. We do not believe we have reached the point of a recession, and a recession may not happen. What is important to understand about yield curve inversions is that in our view, it has a strong track record of predicting recessions, which we believe makes it worth watching as a future predictor of possible market events.

Figure 2: Core Consumer Price Index

Line Chart: CPI 2016 to 2022. High of 6.4361 on 3/31/22, Average of 2.4365, Low of 1.1953 on 6/30/20, SMAVG-6M of 5.6526

Source: FactSet, Federal Reserve. Data as of April 30, 2022. Forecasts are not a reliable indicator of future performance. Positive yield does not imply positive return. Past performance is no guarantee of future results.

The biggest longer-term worry continues to be inflation. The Core Consumer Price Index (CPI) shows a big breakout of inflation (Figure 2). This is mostly attributable to the effects of COVID, which created supply chain issues and demand challenges. Just as some progress was taking hold with supply chains and demand, Russia’s invasion of Ukraine began at the worst possible time and exacerbated inflation concerns. We believe the Fed has the tools to tame inflation but must thread the needle carefully to tame inflation without spooking the capital markets. It will likely take some time, but we believe inflation may begin to level out and recede over the next 12 to 18 months. If inflation does begin to recede, we view the backdrop as a potential opportunity to purchase quality stocks at more attractive prices.

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Kayne Anderson Rudnick Investment Management, LLC (KAR) Logo 960x600 Transparent Primary

This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. It is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation of a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information discussed during the webinar. The information presented should not be considered to be tax advice and all investors should consult their tax professional about the specifics of their own tax situation to determine any proper course of action for them. KAR does not provide tax advice, and nothing herein should be construed as tax advice, and information presented here may not be true or applicable for all income tax situations. Tax laws can and frequently do change, and KAR does not undertake to update this should any changes occur.

Past performance is not indicative of future results.

All investments carry a certain degree of risk, including possible loss of principal.

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