Wealth Management — December 28, 2022
What Happened in the Markets?
- The S&P 500 declined 1.2% Wednesday to close at 3,783.22. The index is now down 20.6% year-to-date.
- Ninety-five percent of the S&P 500 constituents fell on the day as all 11 S&P 500 sectors had losses: Financials (-0.4%) and Health Care (-0.6%) outperformed while Information Technology (-1.6%) and Energy (-2.2%) lagged the index.
- Equity markets headed lower in a light trading session as investors considered China's reopening and the potential implications of higher interest rates on forward earnings and economic activity.
- By the 4 pm equity market close, WTI oil was down 1.2% to $78.59 per barrel while the 10-year US Treasury yield increased to 3.88%.
S&P 500 Price vs 50, 100, 200 Daily Moving Averages
- Earlier this month, after the FOMC decided to slow the pace of the December rate hike to a 50-basis-point (bp) increase and continue significant reductions to the Fed's balance sheet, Fed Chair Powell 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. The FOMC does not anticipate that inflation will come down quickly in the non-housing-related core services segment due to the strength of the labor market, and Fed Chair Powell maintained that additional rate hikes are possible. Once the policy stance is restrictive enough, the committee expects to keep rates stable. The committee will monitor wages and labor market supply/demand imbalances for the February FOMC decision.
- MS & Co.'s Ellen Zentner continues to expect an announcement of a 25 bp hike at the February meeting, helped by the potential for slower job growth. Additionally, she anticipates a peak range of 4.5%-4.75%, after which rates should remain level until December 2023 when a first rate cut of 25bp may occur.
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 MS & Co. 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.
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