Wealth Management — August 10, 2022
- US equity markets closed higher Wednesday: the S&P 500 Index rose 2.1%, while the Nasdaq 100 gained 2.8% and the Russell 2000 improved 2.9%. Meanwhile, 10-year yields rose to 2.79% after reversing a 15 basis point intraday decline.
- Today's CPI report brought investors some ease as it showed headline inflation grew below last month's levels as well as Street expectations. As a result, the short end of the curve declined with 2-year yields down to 3.23%. Traders now appear evenly split in their expectations for the Fed to announce a rate hike between 50 and 75 basis points in September.
- Each of the 11 S&P 500 sectors ended the day higher. Consumer Discretionary (+2.9%) and Materials (+2.9%) were the largest relative outperformers while Utilities (+0.5%) and Energy (+0.7%) lagged.
- As of the 4pm equity market close, WTI oil moved higher to $91.53 per barrel, while gold fell to $1,790 per ounce. The US Dollar Index decreased to near $105.
- Q2 Earnings: Thus far, 90% of the S&P 500 has reported results with 74% beating earnings estimates and 63% surpassing analysts' expectations for 2Q revenues. More than 80% of the constituents within each of the Energy, Industrials, and Real Estate sectors beat estimates and overall, the S&P 500 2Q22 earnings growth is currently at 10.1% (-1.4% excluding Energy), according to Bloomberg. This compares to near 5% growth expectations just three months ago. Despite better-than-expected Q2 results, future quarter growth expectations are trending lower. Since forward earnings estimates do not yet reflect a decline in future profits, the Morgan Stanley Global Investment Committee believes another 10%-15% drawdown is possible: corporate management teams typically reset expectations during the October earnings season when they are better able to forecast the next year, in this case 2023.
- CPI: July's CPI report came in below expectations. Headline fell to 8.5% YoY from 9.1% YoY last month and Core CPI met 5.9% YoY, in-line with June's number. Falling energy costs helped, but declining commodity prices have not yet led to lower food prices. The Fed is far from complete on its path to tame inflation and historically the Fed has not stopped raising the Federal Funds rate until it exceeds core inflation.
- Monetary Policy: In July, the Federal Open Markets Committee (FOMC) announced its unanimous decision for a second consecutive 75-basis-point rate hike. Additionally, Fed Chair Powell indicated that future rate decisions will be made meeting by meeting and "another unusually large increase could be appropriate in September. As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases." MS & Co. economists forecast a 50-basis-point hike at the September FOMC meeting. Regarding the balance sheet reduction program, which is anticipated to ramp through September, Fed Chair Powell communicated that the process to get back to equilibrium may take two to two-and-a-half years.
- Economic Calendar: US PPI (8/11), University of Michigan Consumer Sentiment (8/12).
With the Fed poised to respond to 40-year highs in inflation through both rate hikes and balance sheet run-off in 2022, the GIC’s call for continued caution in the indices remains intact. Our June 2023 base case provides a target of 3,900 for the S&P 500. This scenario assumes earnings and revenue growth decelerates due to high cost pressures in a slowing growth environment. Our June 2023 bear case of 3,350 considers a slowdown in earnings growth rate, margin pressure, sticky inflation, and a recession. Our June 2023 bull case of 4,450 corresponds to a soft landing environment where earnings growth slows but remains positive, inflation decelerates, cost pressures ease, and confidence improves. This bull case forecast embeds an estimate of 17.9x forward June 2024 earnings. With earnings revisions moving lower off the prior peak, investors should focus on risk management through quality factor exposure, defensiveness with regard to interest rate sensitivity, and attention to stock-specific valuations. We are moving to a position of maximum diversification by sector and market cap, with interesting ideas in Energy, Industrials, Materials, Health Care, Consumer Services, Financials, Utilities and Staples. While the US recovery matures, we see opportunities outside the US as relatively more attractive, especially given less expensive valuations and exposure to economic cyclicality. In fixed income, the challenge is two-fold: generating sufficient income, while also preserving capital in a rising rate and higher inflation environment. This requires a diversified and active exposure, with our preference for core investment grade, preferreds, leveraged loans, and asset-backed securities, including select mortgage-backed, and dividend-paying stocks. Real assets such as gold, infrastructure, and real estate present an attractive opportunity as a portfolio ballast for income generation and as an inflation hedge.
Market data provided by Bloomberg.
Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
NASDAQ Composite Index: A broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market.
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
US Trade-Weighted Dollar Index: A weighted average of the foreign exchange value of the 17US dollar against a subset of the broad index currencies that circulate widely outside the US.