Everywhere they look, stock investors see trouble ahead.
Runaway inflation, and the rate hikes designed to contain it, will make life more difficult for consumers. A severe Covid lockdown in China and the invasion of Ukraine are contributing to disruptions in the flow of goods across borders, contributing to rising food and energy prices and threatening corporate profits.
On Wall Street in April, it all seemed to lead to the same conclusion: the economy is about to take a hit.
Those fears led to the S&P 500’s worst monthly decline since the March 2020 panic over the coronavirus. After plunged 3.6 percent on Friday, the index fell 8.8 percent for the month. Shares are now down more than 13 percent in 2022.
The blow was softened somewhat by earnings reports from companies, including some of the most influential tech companies, such as Microsoft and Facebook’s parent company, Meta Platforms, which pleased investors. The labor market and consumption figures also continued to show signs of resilience.
But analysts say Wall Street’s pessimism isn’t likely to end until key concerns are allayed, and when that will happen seems impossible to know.
Most importantly, the impact all this will have on consumers, who make up the bulk of economic activity in the United States. While consumer spending has held up for now, several measurements show that sentiment is eroding rapidly, and economists expect demand to slow as people face high prices and rising borrowing costs at the same time.
“Consumers are the primary driver of the US economy,” said Kathy Bostjancic, chief economist in the US finance division at Oxford Economics. “So how the consumer goes, so goes the economy.” Ms Bostjancic said that as the Fed continues to raise interest rates this year and next, “we are seeing greater consumer vulnerability and increasing risks of a consumer pullback.”
Ms Bostjancic’s company has lowered its expectations for gross domestic product growth this year to 3.1 percent, compared to 5.7 percent reported for 2021. But the outlook for 2023 is where the concerns are especially apparent. Oxford Economics predicts growth will slow to 2 percent, but others predict a recession.
What the Federal Reserve does and says will be crucial. The central bank raised interest rates by a quarter of a percentage point in March, after keeping them close to zero since the start of the coronavirus pandemic. With consumer prices already rising at the fastest pace in four decades, that move was largely to be expected.
But in April, Fed officials began to change their mind, expressed in speeches and other public comments, about how quickly interest rates need to rise to control inflation, and Wall Street’s economic projections also shifted. In the futures market, where traders bet on how high interest rates could go, the prevailing view now is that the Fed’s benchmark will rise to around 2 percent in July — something that seemed unimaginable even a month ago.
For that to happen, the central bank would have to raise its key rate by half a percentage point at each of its next three meetings, starting with a hike next week, and fears are that such aggressive hikes will cause an economic slump, rather than then just cool things down enough to slow inflation but grow the economy.
“Every time the Fed has spoken, the markets have judged it quite negatively,” said Saira Malik, chief investment officer at Nuveen, a global investment manager. “Investors are concerned that with these multiple rate hikes, the Fed will cause a recession rather than a soft landing.”
Higher interest rates will hit consumer demand. Mortgage rates, for example, have already risen above 5 percent, from 3.2 percent at the start of the year, swallowing the budgets of new home buyers. Other borrowing costs, from consumer loans to corporate debt, will rise as the Fed raises its benchmark rate.
For now, many companies — from United Airlines to PepsiCo — are relaying rising costs and reporting that sales continue to rise.
Economists wonder how long this will last.
“There will be a natural slowdown in spending, perhaps before interest rates rise, as costs rise,” said Jean Boivin, head of the BlackRock Investment Institute. “The central bank will have to watch that very closely because if it happens naturally and you add interest rate hikes, you end up with a recession scenario.”
Overall, this week’s earnings reports show earnings growth to continue. About 80 percent of companies in the S&P 500 that reported results through Thursday performed better than analysts expected, data from FactSet shows.
But other companies have only added to the downdraft. Netflix collapsed after it said last week it would lose subscribers — 200,000 in the first three months of the year and another two million in the current quarter. The stock fell more than 49 percent this month.
On Friday, Amazon fell 14.1 percent after the e-commerce giant reported its first quarterly loss since 2015, citing rising fuel and labor costs and warning that sales would slow. The stock fell 23.8% in April.
General Electric warned Tuesday that the economic fallout from Russia’s invasion of Ukraine would weigh on the results. Shares fell 10 percent that day and about 18.5 percent for the month.
The war, which began in February, brought a new risk to the fragile global supply chain: Western countries’ sanctions against Russia, including a ban on the United States’ oil imports, and European pledges to purchase of Russian oil and gas.
Now executives are also assessing how the Covid-19 lockdowns in China could affect profit margins. Multiple cities are locked in the world’s second largest economy, and while factories remain open, China’s draconian ‘zero Covid’ policy has led to interruptions in shipments and delays in delivery times.
Texas Instruments Inc. and machine maker Caterpillar warned investors this week that the lockdowns in China were impacting the company’s manufacturing operations. On Thursday, Apple also warned that the outbreak in China would hamper demand for and production of iPhones and other products. Shares of the company fell 3.7 percent on Friday and ended April with a loss of 9.7 percent.
The outlook for the economy, the effects of the invasion of Ukraine, the lockdowns in China and exactly how quickly the Fed will raise interest rates are still unclear. Markets are likely to remain volatile until they are.
“There are certainly a lot of open and unquantified risks lurking,” said Victoria Greene, the chief investment officer at G Squared Private Wealth, a consulting firm. “The U.S. economy lives and dies for the consumer, and once this consumer starts to slow down, I think that’s going to hit the economy hard.”
