Weekly Investment Update (05/13/2022)

Market Volatility Remains Elevated as Uncertainty Persists

Persistent uncertainty on several fronts has caused market volatility to remain elevated. Market participant concerns include elevated inflation, Russia’s invasion of Ukraine, China’s COVID-zero policy, and the path of the Federal Reserve tightening cycle. The broad set of concerns has led U.S. equity markets to their sixth straight week of declines, the longest losing streak since June 2011. This week, U.S. inflation numbers came in above expectations for April but declined on a year-over-year basis to 8.3% as measured by headline CPI. The conflict in Ukraine continued to drive headline inflation higher with food prices increasing; however, energy-related inflation eased some with a 6.1% drop in gasoline prices. Core CPI inflation moderated to 6.2% in April from 6.5% in March, which was characterized by Fed Vice Chair Brainard as a “notable slowdown.” Although the inflation reading was higher than the consensus forecast, Fed Chair Jerome Powell pushed back against speculation of steeper rate hikes on Thursday. Meanwhile, China signaled its lockdown could be easing within the next week. Easing Chinese COVID policies may act as a catalyst to mitigate rising inflationary pressures due to the impact on supply chains. Currently, shipping times from China to the U.S., and vice versa, stand at all-time highs.

Volatility in the cryptocurrency markets has likewise been profound in the past few weeks. While this volatility is a more inherent feature in crypto markets given crypto is a new and innovative asset class, it can nonetheless be unsettling for investors. Bitcoin and Ethereum, the cryptocurrencies with the longest track records and the most investor participation, have seen these types of precipitous drops several times over their history with the most notable in 2017-2018, when Bitcoin saw an 84% drawdown. While Bitcoin continued to see large drawdowns in the following years since 2018, it still managed to gain 700% during that timeframe. This time, unlike in 2017-2018, the cryptocurrency community is much larger, has more investor participation, and can withstand greater shocks. Although this volatility can be difficult at times for the new asset class, cryptocurrency markets are in a much stronger position than they were in 2017-2018 and are expected to continue expanding and developing going forward.

Sentiment Remains a Potential Tailwind for Markets That Await Bullish Catalysts

With a year-to-date average reading of just 24.4% of AAII investors bullish, this year ranks as the worst year for bullish sentiment in the history of the survey, which dates back to 1987. Equity markets have endured waves of selling pressure from a variety of systematic and discretionary investors. Included in this cohort are volatility control funds, which must de-risk in order to maintain a constant level of volatility in their portfolios; trend-following funds, which have switched from longs to shorts; and discretionary investors, who have reduced risk across the board. As such, equity positioning measured across all investor types is currently in the 10th percentile when measured back to 2010, which leaves potential for a bullish spark to catalyze a more durable rally.

Volatility is likely to remain elevated in the near term as bulls and bears face off to determine the short-term path of equities. However, over the long term, as issues impacting markets are priced and show signs of improvement — the Russia/Ukraine war, Chinese COVID-related lockdowns, supply chain disruptions, and a front-loaded tightening cycle from the Fed — we remain optimistic about the strength of the companies that we invest in to propel longer-term equity market gains. Please see today’s Investment Insights for more information on our equity market views.