Wealth Management — August 12, 2022
What Happened in the Markets?
- The S&P 500 rallied sharply on Friday, gaining 1.7% to close at 4,280. With the rally, the index is now down 10.2% year to date, and 16.7% higher since the June 16 closing low.
- Equity markets closed the week on a constructive note with the S&P 500 Index recording its fourth straight week of gains. Optimism appeared to be centered around the recent market narrative that inflation has peaked following lower-than-consensus CPI and PPI reports on Wednesday and Thursday. Additionally, Friday's better-than-expected University of Michigan Sentiment Index helped to spur further gains into the weekend.
- Q2 earnings season is all but over with more than 90% of S&P 500 companies having reported; on the margin, earnings results were mostly better than expected, but Morgan Stanley's Global Investment Committee remains skeptical on the sustainability of future operating margins.
- Next week, markets will shift attention to data points on housing and retail sales and the July FOMC meeting minutes.
- All 11 S&P 500 sectors ended the day higher. Consumer Discretionary (+2.3%) and Information Technology (+2.1%) were the largest relative outperformers while Consumer Staples (+0.9%) and Energy (+0.8%) lagged.
- As of the 4pm equity market close, the 10-year Treasury yield declined to 2.83% and 2-year yields rose to 3.25%. WTI oil moved lower to just above $91 per barrel, while gold rose to $1,800 per ounce. The US Dollar Index increased modestly.
What to Watch Going Forward
- Q2 Earnings: Thus far, 91% of the S&P 500 Index has reported results with 75% beating earnings estimates and 63% surpassing analysts' expectations for 2Q revenues. More than 80% of the constituents within each of the Consumer Staples, Real Estate and Information Technology sectors beat estimates and overall, the S&P 500 2Q22 blended earnings growth is currently at 6.4%, according to FactSet.
- 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: Empire Manufacturing, NAHB Housing Market Index (8/15); Building Permits, Housing Starts, Industrial Production (8/16); FOMC Meeting Minutes, Retail Sales, (8/17); Jobless Claims, Existing Home Sales (8/18).
The Global Investment Committee’s Outlook
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 2024E 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.