6 factors driving market volatility

As of May 16, 2022

There’s no way to sugarcoat it: Stock performance in April was atrocious.

What was supposed to be a turnaround month for stock prices after weak Q1 performance (given April is historically the best performing month of the year for the S&P 500 Index®) turned into one of the worst April showings in years. The S&P 500 Index finished last month down 8.8%, its worst April return in at least 20 years and its first down start to the second quarter in 10 years.

In addition, the NASDAQ Composite ended the month down 13.3%, its worst month since October 2008. And, so far in May, stocks have continued their slide lower.

Here are six key factors sapping sentiment and weighing on stock prices today:

1. Rising interest rates

The 10-year U.S. Treasury yield has spiked from roughly 1.5% at the end of last year to over 3.0% currently. Higher interest rates erode the present value of future corporate cash flows — hence stocks have reset lower this year in response to higher rates.

2. Tighter Fed policies

Market expectations for future Federal Reserve rate hikes have dramatically shifted higher in 2022. Six months ago, investors expected the Fed wouldn’t lift its fed funds target rate to 1.0% until late 2023. Today, investors expect the Fed’s target rate to sit above 1.0% by June and sit well above 3.0% by mid-2023. Simply, higher rates and tighter monetary policies have equated to lower stock prices this year.

3. Record-high inflation

In April, the headline Consumer Price Index stood at 8.3%, roughly four times the Fed’s preferred range of approximately 2.0%. Surging food, energy, goods, and services prices risk dampening consumer spending over time and sending the U.S. economy into a downtrend. In addition, investors are worried that lingering inflation pressures could cause monetary policies to tighten even more dramatically than currently forecast.

 4. War in Ukraine

The war in Ukraine has caused further upward pressures on food and energy prices while destabilizing relations between Russia and NATO countries. While the war in Eastern Europe appears contained within Ukraine’s borders, elevated geopolitical tensions have sapped risk sentiment and weighed on global growth estimates for this year.

5. Slowing growth in China

China’s manufacturing and non-manufacturing activity continued to contract in April. Officials have installed large-scale COVID-19 lockdowns across two of China’s most economically significant cities, Shanghai and Beijing, to slow the spread of the disease. Investors are concerned slowing growth across the world’s second-largest economy could have adverse knock-on effects for the rest of the world.

 6. Lingering supply chain constraints

While there have been signs of supply chain pressures easing this year, the war in Ukraine and COVID-19 lockdowns in China are preventing further normalization. Transportation costs remain high, and overall supply chain disruptions (while moderating from their peak) are still elevated. Simply, supply chain disruptions add to keeping inflation and interest rates high and sour stock sentiment.

But there are bright spots

Despite the risks listed above, there are some positive indicators in the current landscape:

  • When there is this much doom and gloom about future stock returns, forward returns over the next year tend to be outsized versus history. Bullish sentiment currently sits at some of the weakest levels in 50 years.

  • The COVID-19 rally bubble has been bursting under the surface for a while. As Bespoke Investment Group recently noted, the average NASDAQ stock is 46.5% “below” its 52-week high, as of May 6. If investors are looking for stocks on sale, they’ll likely find many opportunities within the NASDAQ today.

  • With that said, bubbles can take time to burst. Stocks can also overcorrect to the downside following rapid and powerful upswings. Investors should lean on sound investment advice during these periods of volatility and ensure they have ample exposure to high-quality investments.

  • Now that the earnings season is winding down, the main takeaway from Q1 reports is that company fundamentals remain strong. It’s just no one cares right now. In our view, investors are largely underappreciating the still strong corporate backdrop, which should remain solid in Q2.

  • Job growth in the U.S. remains robust and should support still healthy consumer trends. And while the pace of job growth is slowing from its post-pandemic tear, a tight labor market, low unemployment (3.6% in April), and healthy wages are signs the consumer stands on solid footing today.

What’s next for stocks?

Unfortunately, market sentiment remains weak, stock momentum is biased to the downside, and there is a shortage of catalysts to motivate buyers. As it stands today, that backdrop is unlikely to change over the near term, given the Fed is expected to raise interest rates aggressively.

We believe the stock market might continue to churn until equities move from traders’ hands to longer-term investors willing to “own” stocks. During these transition periods, market volatility is often elevated. And that volatility remains elevated until a floor is found, and where longer-term owners of equities believe the risk is worth the reward. History suggests stocks, in aggregate, should eventually reach a capitulation point and allow longer-term investors a solid entry point, which should help change the market narrative over time.

Bottom line: There may be more room for speculation to wash out of stocks over the coming weeks and months, notably if rates climb higher. This could keep overall market volatility elevated and impose some risk of collateral damage to the broader market. But as hard as it is to stomach today, washing out most of the excessive market speculation is necessary for returning to a healthy, more stable investing environment.

In our view, investors should be thinking less about how much further stocks have to fall at this point and more about what might prompt a positive change in momentum and if their portfolio is positioned correctly for that change. That shift in sentiment could occur once investors have a better grip on when the pace of inflation might slow and when the Fed might stop hiking interest rates.

Concerned about recent market volatility?

If any market developments are giving you pause, it’s time to connect with your Ameriprise financial advisor. They can provide perspective unique to your situation and are here to help ensure your investment portfolio remains diversified and consistent with your risk tolerance, time horizon and asset allocation targets.

Data source for indice and sector graphs: Morningstar Direct, as of May 6, 2022.Past performance is not a guarantee of future results.