OUR VIEW

A look ahead: Second quarter 2022 outlook

04/19/2022

Prices, profits, and price-to-earnings multiples remain the keys to market performance

Prices

The Russian invasion has caused commodity prices, especially oil, to surge. A more significant longer-term issue with inflation is labor price pressure and consumer inflation expectations, both of which continue to build.

Equity market performance had been understandably weak at the onset of the Federal Reserve’s (Fed) rate hiking cycle, but more recently stocks have actually risen in tandem with bond yields, a possible sign that the equity market is getting more comfortable with the Fed’s tactics in restraining inflation.

Profits

Corporate profitability has been the main buttress in supporting the equity market. Fourth-quarter 2021 profits were quite strong as the impacts of the pandemic began to recede. Upcoming first-quarter earnings reports will be carefully scrutinized regarding the impact that both input price pressure and escalating labor costs may have on profitability.

P/E multiples

The currently higher price/earnings (P/E) valuations can be justified by exceptionally low interest rates and when growth rates are high.

Valuations and P/E multiples are more likely to remain stable or moderately lower, with markets driven primarily by earnings.

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Asset allocation views: Current outlook

Tactical vs. strategic position

Equity vs. Fixed Income

Thrivent’s viewpoint is a maintained overweight to equity; however, it is becoming increasingly difficult to remain positive on the market.

We expect a predominately sideways trade, accompanied by higher levels of volatility, especially when contrasted with the post-shutdown rally.

Equities

U.S. vs. Int'l.

Within international markets, we remain modestly overweight developed markets versus emerging markets.

Longer-term, China’s rapidly aging population and falling birthrate combined with a material debt burden are structural impediments to growth. Near-term, rising geopolitical tensions with Hong Kong and Taiwan in addition to Covid Zero policies that result in lock-downs increase pressure on economic growth.

Within developed markets, inflation is acute. On a relative basis, Europe is severely affected by the war in Ukraine. Energy and food costs were already high and are now surging further to levels not seen in decades.

Market Cap

We remain overweight small- and mid-caps. However, more cyclical areas of the market—including small-caps and value—tend to move closely with U.S. macro leading indicators such as PMIs and consumer confidence.

Small-caps had substantially outperformed with the liquidity induced rally at the end of 2020 into early 2021, soaring some 35% above large-caps. Since then, they have underperformed approximately 25%.

While the more recent underperformance diminishes some of the relative risk to larger caps, a Federal Reserve (Fed) tightening cycle with decelerating growth presents a tough environment for small-caps and cyclicals, overall.

Fixed-income

Duration

During the quarter, ten-year rates rose 83 basis points from 1.51% to 2.34%. A large part of this increase in rates was due to inflation and the Fed’s reaction to it.

Low unemployment also played a role. During the quarter, the Fed commenced tightening by 25 basis points in March and is expected to continue past 2022, with some increases of 50 basis points. As a result, two-year interest rates increased by 160 basis points from 0.73% to 2.33%. Fed policy affects short-term rates more than long-term rates. Thirty-year interest rates increased from 1.90% to 2.45%.

We expect there will be continued pressure toward higher interest rates going into 2022. Our Funds tend to have shorter durations, which should reduce the adverse impact of rising interest rates.

Yield Curve

Like last quarter, a flattening of the yield curve was a dominant theme during the first quarter.

Another yield curve we like is the spread between 3-month Treasury Bills and 10- year Treasury Notes. This curve typically gives a closer forecast of a recession. Currently it is quite steep and not predicting an imminent recession.

Credit Quality¹

Credit spreads declined again in the third quarter, falling far below long-term averages.

We expect credit spreads to stay relatively range-bound with some slight tightening; however, the low spread levels make corporate credit more susceptible to backups on negative news.

High-quality credit, though, continues to offer little absolute yield and remains sensitive to interest rate increases, so we continue to modestly prefer lower quality sectors, like high yield and leveraged loans.

We also favor selectively seeking yield in alternative fixed-income sectors, such as preferred securities and fixed-income closed-end funds.

¹ Credit Quality ratings are determined by credit rating agencies Moody’s Investor Services, Inc. or Standard & Poor’s Financial Services, LLC.

The Senior Investment Team is discussing the asset classes, sectors and portfolios they oversee at a macroeconomic level. The views expressed are as of the date given unless otherwise noted and may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or recommendations of any particular security, strategy or product.

Past performance is not necessarily indicative of future results.

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