Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., March 29, 2022.
Brendan Mcdermid | Reuters
The stock market is heading into what promises to be a volatile second quarter, but April is traditionally the best month of the year for stocks.
The major indices were higher in March, but they turned in a weak performance for the first quarter, the worst since the pandemic. Investors have been worried about rising interest rates, the war in Ukraine and inflation, which was made even worse by disruptions in commodities exports from both Russia and Ukraine.
Stocks are typically higher in April, and it is historically the best month of the year for the S&P 500. The S&P has been higher 70% of the time and has gained an average 1.7% in all Aprils since World War II, according to Sam Stovall, chief investment strategist at CFRA. For all months, the S&P averaged a gain of 0.7%.
The S&P 500 was up 3.6% in March, and Stovall said the rally could continue. “I think we get back to breakeven, but then I wouldn’t be surprised if we go through another pullback or correction before we have an end of year rally,” he said.
Market focus in the week ahead will remain squarely on developments around the Ukraine war and on the Federal Reserve. The Fed on Wednesday is scheduled to release minutes from its March meeting, where it raised interest rates for the first time since 2018.
There are also a handful of Fed speakers, including Fed Governor Lael Brainard, who speaks Tuesday.
Greg Faranello, AmeriVet Securities head of U.S. rates, said the Fed minutes could be the highlight of the week since the central bank is likely to provide more detail on its plans to shrink its balance sheet. The Fed has nearly $9 trillion in securities on its balance sheet, and a reduction of those holdings would be another step to tighten policy.
“The market is curious. They’re going to be looking for some clues in terms of how quickly, how big, what the caps look like,” said Faranello.
The economic data calendar is light, with factory orders Monday, international trade and ISM services Tuesday and wholesale trade Friday.
Traders will also be watching for any comments from companies ahead of the first-quarter earnings reporting season, which starts in mid-April.
“The first-quarter earnings have actually been improving in the last month, so that’s encouraging,” said Stovall.
Farewell to first quarter
The Dow was off 4.6% for the first quarter, while the S&P 500 was down 5%. The worst performer by far was the Nasdaq, down 9.1%. In the past week, stocks were barely changed. The Dow was down 0.1%, while the S&P was up 0.1%. The Nasdaq was up 0.7%.
Interest rates also moved dramatically during the quarter, with the benchmark 10-year Treasury yield temporarily touching a high of 2.55% in the past week, after starting the quarter at 1.51%.
On Friday, the 10-year was yielding 2.37%, while the two-year yield, which most reflects Fed policy, was at 2.45%. The two-year was yielding 0.73% at the beginning of the year.
Faranello said bond yields can keep going higher on inflation concerns, but they could consolidate before another big move.
“I think the market is looking for a new catalyst here,” he said. “I just think the first quarter has been about repricing the market, and we’ve done that…The Fed came out very hawkish. We made made a dramatic repricing. Now, we need to see more data to see how this is going to evolve in the second quarter.”
Stovall said the S&P 500’s first-quarter performance is one of the 15 worst first quarters, going back to 1945. After those weak quarters, down 3.8% or more, the second quarter was better on average. This year’s first-quarter decline was tied with 1994, which had the 12th worst first quarter.
After those 15 weak first quarters, “we actually climbed 4.8% in the second quarter and rose in price two out of every three times,” he said. But for the full year, the S&P 500 gained just 40% of the time, and was down an average 2% in those years.
But this year is a midterm election year, and in those years the second and third quarters are typically the weakest. “Of those 15 worst quarters, five of them were midterm election years, and of those five, the second quarter was up an average 1%, and it rose in price only 40% of the time,” Stovall said.
Stovall said the market could be higher in the second quarter, but it will face headwinds. “Oil prices are likely to remain up. Interest rates are certainly not coming down,” he said, adding geopolitical pressures are likely to remain. “I see the possibility of a 1% gain. We could probably eke out something good.”
Stocks were held hostage by rising and volatile oil prices in the first quarter, as the world scrambled to make up for Russia’s export barrels. Many customers refused to buy Russian oil for fear of running afoul of financial sanctions on Russia’s financial system.
After wild swings both higher and lower, West Texas Intermediate oil futures gained 39% in the first quarter, the eighth positive quarter in a row and its best first quarter since 1999. WTI was just under $100 per barrel Friday afternoon.
Choppy, volatile market
Joe Quinlan, head of CIO Market Strategy for Merrill and Bank of America Private Bank, said he is constructive on the market heading into the second quarter, but he sees some rough spots ahead.
“We’ve got to work through the inflation problem, and the Fed catching up to the expectations of the market,” Quinlan said. “We’ve got to re-anchor inflation. It’s going to be a choppy, volatile year. We’re tilting more toward hard assets, whether it’s commodities, energy and natural gas.”
Quinlan said he leans towards equities over fixed income, which has also been unusually volatile. “We’re using equities as a hedge against inflation,” he said. “Within that framework is more hard assets, fuels, agriculture complex in general and metals and minerals.”
In the second quarter, the stock market will continue to adjust to an aggressive Federal Reserve against the backdrop of what should have been a solid economy. With 431,000 payrolls added in March, jobs data continues to be strong, but there is a fear the Fed will raise interest rates too quickly, derailing the economy and spinning it into recession.
Traders in the futures market expect the Fed will increase its fire power at its next meeting in early May, hiking interest rates by 50 basis points, or a half-percent. The Fed’s first rate increase was a quarter-point at its March meeting.
The market is pricing in the equivalent of eight quarter-point hikes, and Treasury yields have moved higher with stunning speed as market expectations for interest rates shifted. The two-year Treasury yield rose above the 10-year yield, or inverted this past week, for the first time since 2019. That is viewed by the market as a warning sign for a recession.
Fed officials have signaled they want to move to trim the balance sheet soon. Kansas City Fed President Esther George this past week said the Fed’s balance sheet will need to decline significantly. She said the Fed’s holdings of Treasurys may have depressed the 10-year yield, causing the yield curve to invert.
Faranello said interest rates could still head higher on inflation worries, but rates could consolidate after their recent run higher. The yield curve could also remain inverted.
“We can stay like this for a year-and-a-half. Everyone’s screaming a recession is coming…I don’t think the yield curve is telling us a recession is just about to happen,” Faranello said.
Week ahead calendar
10:00 a.m. Factory orders
8:30 a.m. International trade
9:45 a.m. Services PMI
10:00 a.m. ISM Services
10:00 a.m. Fed Governor Lael Brainard and Minneapolis Fed President Neel Kashkari
2:00 p.m. New York Fed President John Williams
Earnings: Levi Strauss
9:30 a.m. Philadelphia Fed President Patrick Harker
2:00 p.m. FOMC minutes
Earnings: WD-40, Conagra Brands, Constellation Brands, Lamb Weston
9:00 a.m. St. Louis Fed President James Bullard
8:30a.m. Initial claims
2:00 p.m. Atlanta Fed President Raphael Bostic
2:00 p.m. Chicago Fed President Charles Evans
3:00 p.m. Consumer credit
4:05 p.m. New York Fed’s Williams
10:00 a.m. Wholesale trade