Glad The Q1 Is Done…
Following strong performance in 2021, both equity and fixed income markets were challenged during Q1 with the S&P 500 Index declining 4.6% while bonds posted their worst quarterly performance in over four decades. Investor concerns around record recent inflation figures, rising interest rates and lingering supply chain disruptions were further exacerbated by the early March invasion of Ukraine.
As we wrote in our March 15th interim update, we do not believe that the conflict in Ukraine will have a material intermediate- or long-term impact on global growth, dislocation in the food and energy sectors notwithstanding. At the same time, the recent spike in inflation has been driven, in our view, by transitory factors while many of the underlying fundamentals that have supported a benign inflation environment - technology innovation, in particular, remain intact. Globalization, fundamentally deflationary, appears to be still a thing even with higher frequency of saber-rattling and jingoistic nationalism. In 2021, total trade approached $30 trillion for the first time, 13% higher than pre-pandemic levels.
Our constructive view on inflation does not mean that we would be surprised to see interest rates trend higher in the near-term. Bonds are coming off a 40-year bull market; moreover, in response to Covid 19, governments around the world have injected unprecedented liquidity into the global money supply in an effort to support economic growth while also initiating levels of fiscal stimulus unseen since the Great Depression. As of this writing, 10-year treasury yields have risen to 2.9%, up from just 90 basis points at the beginning of 2022.
Rising rates reduce the present value of future earnings and so are particularly impactful on growth stocks. Indeed, the Russell 1000 Growth declined 9.8% during the Q1, underperforming the broader market by over 500 basis points. The broader market as defined by the S&P 500, is currently trading at 17 times forward earnings, below the five-year average of 18.5 times and only slightly above the 25-year trendline. Treasury yields meanwhile, remain below their historic average.
Investors have alternatives; balancing the trade-off between higher potential returns and greater volatility is an ongoing process. Over the long-term, investors have typically demanded a 200 basis point risk premium to invest in equities relative to bonds. When the risk premium is higher, we would view equities as attractive with the converse holding true as well. The earnings yield of the S&P 500 Index is currently 5.8% or 292 basis points over the treasury yield, above the historic trend. Accordingly, we continue to view equities in general, as attractive.
We’re monitoring economic factors and company-specific trends carefully and thus far Q1 earnings reports have reflected strong underlying demand, most companies have beaten estimates and their guidance for the remainder of the year does not imply an impending recession. However, to the extent the economic environment becomes more challenging - a prospect being signaled today by the inversion of the yield curve - we’d view Roanoke’s holdings of rock-solid growth companies whose valuations have already become more attractive in response to rising interest rates, as even more compelling.
If you have any questions about our comments or your portfolio, please be in touch. We like hearing from you.