What investors should watch for in Q2


Anthony Saglimbene, Global Market Strategist – Ameriprise Financial

As of April 18, 2022

 

Markets endured an unusually high level of volatility in the first three months of the year. Rising interest rates, record-high inflation levels, elevated geopolitical threats (driven by Russia's invasion of Ukraine), and expectations for tighter Federal Reserve policies put stocks and bonds on the defensive through much of the first quarter.

As we begin the second quarter, here is a look back at Q1 and what to watch for in Q2.

 

A look back at Q1

The S&P 500® Index ended the first quarter of the year lower by 4.6% on a total return basis, the first quarterly loss since the depths of the pandemic in Q1 2020. Likewise, the tech-heavy NASDAQ Composite finished Q1 down by 9.0%, while the value-centric Dow Jones Industrials Average lost 4.1%. Additionally, the Bloomberg U.S. Universal Bond Index finished Q1 lower by 6.1%.

In our view, stocks demonstrated incredible resiliency in such a challenging environment. It's important to note that stock prices generally trace profit expectations over time. Currently, analyst estimates suggest S&P 500 earnings will be solidly higher over the next 12 months, which in our view, has offered support for stocks in an otherwise uncertain environment. We also believe stock valuations across several areas of the market have improved given the weaker performance in Q1 and pose longer-term opportunities for investors willing to look past current volatility.

The more bullish themes for stocks continue to point to oversold conditions and depressed sentiment indicators, generally considered a contrarian indicator for longer-term investors. Also, stocks tend to perform well in inflationary environments and can act as a hedge against rising price pressures.

 

Data source for indice and sector graphs: Morningstar Direct, as of March 31, 2022.
Past performance is not a guarantee of future results.

 

Why the Q1 earnings season is all about the consumer

We expect a messy earnings season over the coming weeks. As earnings reports come in over the coming  weeks, here is what investors should keep in mind:

  • Stock prices could move on three key factors. Companies that effectively navigate through inflation and supply disruptions and can provide a visible/stable outlook are likely to be rewarded with higher stock prices following their earnings releases. Conversely, companies that do not deliver on expectations or provide more clouded outlooks could see their stocks pressured.

  • Higher prices likely funneled into corporate sales during the first quarter. If analysts prove too conservative with their Q1 earnings estimates, stocks could see some upside momentum over the earnings season on more robust profit trends, as higher sales and strong pricing power could help companies protect elevated profit margins.
     
  • The Q1 earnings season should provide a window into how consumers are responding to higher inflation across a range of products and services. While consumers have $2.5 trillion in excess savings, soaring food and energy prices, often in consumers' faces daily, run the risk of dampening demand for other more discretionary items over time. In addition, we believe investors will specifically want to know if companies, which have primarily passed on costs to this point to protect profit margins, are starting to see demand erode. How companies are addressing disrupted supply chains, adapting to slowing growth, and if the backup in rates has caused changes to capital plans will likely be other items investors key in on during earnings calls over the coming weeks.

  • It's all about the consumer in the second quarter and if, in aggregate, they can hold their spending levels under record-high inflation. The U.S. consumer represents roughly 70% of the U.S. economy. How they feel about their unique circumstances and their subsequent actions in response to changing conditions largely dictates the direction of growth. However, the U.S. economy has created more than half a million jobs on average this year, which is on par with last year's pace. Bottom line: The labor market is strong and adds a solid layer of support for consumers and stock prices, in our view.

 

Key themes to watch in Q2

Fed movement

Investors will be paying close attention to Federal Reserve actions that potentially front-load interest rate hikes this year and thus how such rate hikes affect the shape of the yield curve. Fed actions perceived by the market as “too aggressive” could keep volatility elevated in the second quarter.

Wage growth

The Federal Reserve is likely to closely watch wage growth trends as it determines the shape of rate policy and keeps tabs on whether inflation pressures become unanchored. We expect average hourly earnings growth to moderate in the coming months, which could help quell concerns that inflation pressures are swirling out of control. Moreover, we believe stocks could eventually react more favorably to developments that show wage inflation moderating, implying that Fed rate hikes won't need to be as aggressive (potentially in the back half of the year) as currently feared. 

Commodity prices and geopolitical tensions

Russia/Ukraine developments are likely to simmer in the background. The direction of commodity prices, global economic effects from Russian sanctions, and efforts to keep the conflict contained could be critical items to watch as the Russia/Ukraine War further unfolds in Q2.

Data source for indice and sector graphs: Morningstar Direct, as of March 31, 2022.
Past performance is not a guarantee of future results.

 

Recession noise

On a brighter note, recession odds for this year remain very low. Consumer/business balance sheets are solid, and corporate profits are expected to grow. As long as the economy and profits are growing, we believe the market can look through many of the other macro issues discussed.

 

What investors should keep in mind

Importantly, much of the risks noted above are known to investors and, to some extent, priced into stocks today. Nevertheless, volatility feels uncomfortable and often creates anxiety among investors. This anxiety can lead investors into making portfolio changes that are, more often than not, damaging to their longer-term success.

Advice that centers on diversification, staying the course, looking through the day-to-day noise, and focusing on the longer term can feel unsatisfying against mounting uncertainties. But if investors have a longer time horizon, drawdowns in the market tend to be solid buying opportunities. Today, stocks are materially higher than at the depths of the COVID-19 crash, the Financial Crisis, 9/11, and the dot-com bust. Yet, a host of concerns and uncertainties may have caused investors to second-guess their investment strategies in each period.

History shows that if one incorporates a disciplined investment approach and doesn’t deviate materially when the waters get rough, one can usually weather the waves and eventually take advantage of market gains during calmer seas. We believe it's advice worth noting as the second quarter begins.       

 

Questions?

If you have any concerns about the impact of current market conditions on you portfolio, make sure to reach out to your Ameriprise financial advisor. They know your personal situation and can answer any questions you have.