Wealth Management — December 15, 2022
What Happened in the Markets?
- The S&P 500 declined 2.5% Thursday to close at 3,896. The index is now down 18.3% year-to-date.
- All 11 S&P 500 sectors dipped Thursday as Energy (-0.6%) and Utilities (-1.3%) outperformed while IT (-3.8%) and Communication Services (-3.8%) lagged the index.
- Equity markets headed lower and the US Dollar Index rallied as investors considered US economic data releases and the potential effects of the Fed's and the ECB's decisions to slow their rate hikes to 50-basis-point increases.
- Today's US economic data reports showed labor market strength but weaker retail sales and industrial production. The retail sales report noted a cooling in spending in November (the most since last December) following a strong October amid the holiday shopping season. Spending grew in only four of the 13 categories, and motor vehicle sales declined the most (-2.3% MoM). This slowdown follows inflationary pressures and may reflect consumers' continued shift in spending from goods to services. Additionally, the industrial production report highlighted weaker goods manufacturing, with motor vehicles and parts declining 3.1% MoM.
- By the 4 pm equity market close, WTI oil declined 1.5% to $76 per barrel. The 10-year US Treasury yield decreased 3 basis points to 3.45% while the US Dollar Index rose 0.8%.
What to Watch Going Forward
- Monetary Policy: This week Fed Chair Powell announced the FOMC decided to slow the pace of the December rate hike to a 50-basis-point increase, taking the federal funds rate to 4.25%-4.50%, while continuing the significant reductions to the Fed's balance sheet. He noted that "it is good to see progress, (but) there is still a long way to go" before the committee is confident inflation is moving closer to the 2% goal. It will take time for the full effect of the restrictive policy actions to be felt in the economy. He noted that ongoing rate increases are possible, when appropriate. While the CPI report showed inflation continued to ease in November, the FOMC is watchful of the non-housing related core services segment, which remains elevated due to the strength of the labor market. The committee does not anticipate that inflation will come down quickly in this segment and noted that additional rate hikes are possible. Once the policy stance is restrictive enough, the committee expects to keep rates stable. The FOMC's Summary of Economic Projections (SEP) shows a median expectation of a 5.1% rate in 2023, 4.1% in 2024, and 3.1% in 2025, illustrating additional rate increases. Fed Chair Powell indicated that the rate decision following the February 1, 2023 FOMC meeting will be based on data and economic financial conditions at that time. The committee will be monitoring wages and labor market supply/demand imbalances for the decision. MS & Co.'s Ellen Zentner continues to expect an announcement of a 25-basis-point hike at the January 31-February 1, 2023 meeting, helped by the potential for slower job growth. Additionally, she anticipates a peak range of 4.5%-4.75% after which rates will remain level until December 2023 when a first rate cut of 25 basis points may occur.
US Economic Releases
- 12/16: S&P Global PMIs
The Global Investment Committee’s Outlook
With the Fed responding to 40-year highs in inflation through both rate hikes and balance sheet run-off in 2022, the GIC’s call for continued caution remains intact. Corporate earnings revisions have moved lower over the course of the year, suggesting downside to forward earnings growth. We recommend investors focus on risk management through quality cash flows, defensiveness, and attention to stock-specific valuations. We suggest rebalancing portfolios and tax-loss harvesting during bear market rallies. In fixed income, the challenge is two-fold: generating sufficient income, while also preserving capital, given the potential for higher yields amid ongoing inflation. This requires diversified and active exposure, with our preference for core investment grade fixed income and dividend-paying stocks. Consider revisiting positioning in long-duration/growth equities, where there may not be adequate compensation for the risks of higher real rates, falling operating leverage and the strong US dollar.
For US equities, the US Equity Strategy team sees the potential for further equity downside in the early part of 2023, given their base-case expectations of $195 for 2023E earnings, well below current consensus levels. Their 2023E S&P 500 base case provides a target of 3,900, based on 2024E earnings of $241. This scenario assumes that nominal top-line growth slows to the low single digits and that margins contract. Their 2023E bear case of 3,500 considers a severe earnings recession, margin pressure and a contraction of EPS growth. Their 2023E bull case of 4,200 corresponds to a mid-single-digit top-line growth rate and limited margin compression. This bull case forecast embeds an estimate of 16.7x MS & Co.'s forward 2024E earnings of $251.
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 US dollar against a subset of the broad index currencies that circulate widely outside the US.