Green denotes updated information

Growth

1Q22 Real GDP showed the economy contracted at a 1.4% annual rate in 1Q22, a deceleration from the boomy 4Q21. Weakness was primarily led by volatile trade and inventory data. Trade subtracted 3.2% from overall GDP growth as exports fell sharply and imports soared. Real private inventories grew at a solid $158.7Bn annual pace, but came in below its record 4Q21 pace. Weakness was partially offset by strong consumer spending, which grew by 2.7% ann. in the first quarter. At the start of the second quarter, flash PMIs show U.S. business activity slowed in April as soaring costs for raw materials, fuel and labor pushed input prices to a record high. The flash Composite PMI Index fell to 55.1 from 57.7 in March. 

Jobs

April nonfarm payrolls rose by a robust 428K with modest downward revisions of 39K to the prior two months. The unemployment rate stayed steady at 3.6%, while the labor force participation rate surprisingly dropped to 62.5% from 62.4%. Wage growth moderated at 0.3%, while March was upwardly revised to 0.5%. The labor force fell by 368,000, with the loss primarily concentrated in younger aged Americans. Labor supply continues to be a problem and places a ceiling on the pace of job gains. However, investors should also take some comfort, as strong job gains continue to reflect a robust labor market and a moderation in wage growth should cool worries about stagflation. 

Profits

After a solid 4Q 2021 earnings season, 1Q 2022 earnings have held up better than expected. With 461 companies having reported (91.4% of market cap), our current estimate for 1Q 2022 is $50.07 ($41.55 exfinancials). 74% of companies have beaten on earnings expectations and 66% have beaten on revenue expectations. Omicron, higher inflation, disrupted supply chains and a slightly stronger dollar are weighing on profits. However, we expect robust economic growth and a surge in energy prices to continue to provide support for earnings.

Inflation

Inflation has far exceeded the FOMC’s 2% target, with the headline PCE price index rising +0.9% m/m and +6.6% y/y in March. The core PCE deflator also rose +0.3% m/m and +5.2% y/y. The March CPI report showed hotter-than-expected inflation despite hopes for a slowdown. Headline CPI rose 0.3% m/m and 8.3% y/y, while Core CPI jumped 0.6% m/m and 6.2% y/y. While declines in energy prices led a moderation in headline CPI, core inflation accelerated as airfares, new vehicle prices and shelter costs rose solidly.

Rates

A rapidly improving labor market and persistent inflationary pressures have pushed the Fed to begin tightening. At its May meeting, the FOMC announced a 0.50% increase in the federal funds target range to 0.75%-1.00% and signaled further increases of the same magnitude as it struggles to tame inflation. At its March meeting, the Fed delivered hawkish forward guidance by way of its updated summary of economic projections and median “dot” plot. Real GDP was downgraded materially from 4.0% to 2.8% y/y in 4Q22 while PCE inflation was revised markedly higher to 4.3% y/y. The median FOMC member expects 7 rate hikes in 2022, though markets have gone above this guidance and expect around 10 rate hikes in 2022.

Risks

• Heightened geopolitical tensions with Russia could result in severe energy shortages, worse consumer confidence and dampened growth.
• Inflation could spike further and remain elevated for longer if energy shortages worsen.
• The removal of policy support and stretched valuations could provide a challenging backdrop for equities.

Investment Themes

• U.S. equity investors may use earnings as a guide in a rising rate environment.
• Fixed income investors may want to underweight duration and explore alternative sources of income.
• Long-term growth prospects, a falling dollar and cyclicality support international equities.

0903c02a81e20947