The U.S. Federal Reserve is opting to be more aggressive with its latest increase in the federal funds rate. In the past, the Fed has commonly raised rates in increments of 25 basis points, but the latest hike is expected to be 50 basis points. Fed Chair Jerome Powell has said taming inflation is “absolutely essential.”1

Persistently high inflation demands the aggressive approach. The Consumer Price Index in March was 8.5% higher than it was a year ago, the highest annual rate of inflation since 1981.2

Home prices continued to soar, as well. Recently released data for February showed home prices had risen 19.8% above where they were a year ago.3 That was the third highest reading in the 35-year history of the S&P CoreLogic Case-Shiller national home price index. The hot housing market could begin to cool, however, now that the average rate for a 30-year mortgage has risen to 5.11%, the highest level for mortgage rates in 12 years.4

One indicator that offered some hope inflation could be peaking was the Mannheim Used Vehicle Value Index. At least on a seasonally adjusted basis, the index was down 1.0% for the first 15 days of April from where it had been for the month of March.5

U.S. economy shrinks in first quarter

U.S. gross domestic product declined at an annualized rate of 1.4% in the first quarter, according to preliminary estimates from the U.S. Commerce Department.6 The contraction surprised many, given that the economy had grown at an annualized rate of 6.9% in the fourth quarter of 2021. On a promising note, real final sales to domestic purchasers, which is an indication of underlying demand without factoring in trade and inventories components, increased at an annualized rate of 2.6%.

The mixed story led Bloomberg economist Yelena Shulyatyeva to conclude that the drag on GDP from trade – which was caused by weak global economic, a strong dollar and strong domestic demand -- will be only temporary. She noted that Bloomberg’s team of economists believes that the business and consumer spending, which has been gaining momentum in the second quarter, will push GDP above its historical average growth rates for the year.

China looks to reverse economic impact of its “zero-Covid” policy

Hong Kong stocks rallied at month end as the Chinese government announced it would commit to meeting its targets for economic growth. Growth in the country has slowed because of President Xi Jinping’s Covid Zero strategy, which has forced major cities like Shanghai to shut down. That has disrupted global supply chains and impaired the operations of many companies, including U.S. firms like Tesla and Apple. The government promised to guarantee supply chains in key sectors, improve transport logistics, and respond to requests from foreign companies with investments in China for a smoother business operating environment. While the announcement was short on specifics on how all that would be achieved, the government’s commitment to its target economic growth rate of 5.5% was enough to buoy investors’ confidence.7

Military contractors’ stock prices may be spiking too soon

On April 21, President Biden promised to deliver another $800 million in military aid to Ukraine.8 That was followed at month’s end by a request from the administration for the U.S. Congress to fund a total of $33 billion in military, economic and military aid for the country.9 From an economic and investment perspective, it’s important to note that while the U.S. and other countries are sending more weapons to Ukraine, the war may not bring an immediate increase in revenue for defense contractors like Lockheed-Martin and Raytheon.7

As investors, we remain cautious about this sector. In our view, war-driven sentiment has pushed the stock prices for military contractors too high. Our research suggests that it can be two to three years before a spike in geopolitical risks translates into any significant increase in earnings for the military contractors.

Twitter purchase and Netflix’s woes dominate stock news

April has been a difficult month for U.S. stocks, with the major indexes experiencing declines. While tech stocks have experienced some of the most significant drops in prices, a few companies have been dominating the headlines. On April 25, Twitter’s board approved a $44-billion acquisition of the company by Elon Musk.

That news brought a decline in the stock price of one of Musk’s other companies – Tesla. Wall Street may be concerned about the terms of the deal, given that the purchase is being funded by $25.5 billion in debt, $12.5 billion of which is loans against Musk’s Tesla stock.10 Analysts may also have doubts about how much attention Musk will be able to devote to Tesla, given that, after the Twitter deal closes in the next three to six months, he will be leading three major companies: Twitter, Tesla and SpaceX.

The once high-flying Netflix stock also experienced steep declines, as the company reported a quarterly loss in subscribers for the first time in more than 10 years.11 The company experienced a net loss of 200,000 subscribers from January to March of this year. Pulling out of Russia caused the company to lose 700,000 subscribers, a drop it partially offset by gaining 500,000 new customers elsewhere. It projected another net loss in its subscriber base for the second quarter.

The decline in Netflix’s stock price was also accelerated by the decision this month from billionaire investor Bill Ackman to exit the stock.12 His hedge fund, Pershing Square Capital, had acquired 3.1 million shares of the company’s stock just three months ago. He said the decision to sell Netflix stemmed from an inability to project with any certainty what the company’s prospects are.

The diminished outlook for Netflix has been attributed to increased competition from other streaming services, as well as the end of the pandemic-induced lockdowns when people have few choices for entertainment. Netflix joins a host of other names that have come back to earth after their stocks were pricing in exponential growth several years into the future. The more of this we see, the more comfortable the Federal Reserve may feel with backing off its monetary tightening even slightly.

Tags: Geopolitical, Inflation, Interest rates