Wealth Management — January 5, 2022
- US stocks traded lower on Wednesday as the S&P 500 declined 1.9% to close at 4,701. With the sell-off, the index is down 1.4% year to date.
- Equities took their cue from rates markets on Wednesday, as the release of the December FOMC meeting minutes in the afternoon appeared to signal a more hawkish outlook for monetary policy, sending yields higher across the curve. The release of the minutes from last month's FOMC meeting point to a central bank that is turning decidedly more hawkish with several members believing inflation risks are growing and that both rate hikes and balance sheet normalization could be appropriate in 2022. As yields moved higher, perceived rate-sensitive equities sold off sharply, with Real Estate and high-multiple growth stocks the big laggards on the session; to that point the NASDAQ Composite ended the session more than 3% lower.
- All 11 S&P 500 sectors traded lower on Wednesday, with Consumer Staples (-0.03%) and Utilities (-0.04%) outperforming the broader market, while Information Technology (-3.1%) and Real Estate (-3.2%) lagged.
- Rates were sharply higher across the curve, with the 10-year Treasury yield rising to 1.70% as of the 4 p.m. equity market close. Gold was slightly lower on the day while WTI was modestly higher at over $77 per barrel. The US dollar was flat on the trading session, as measured by the US Dollar Index.
Equity markets traded lower on Wednesday as the S&P 500 fell 1.9%. While the year was off to a strong start as cyclicals and value-oriented stocks drove the market higher in recent sessions, on Wednesday equities reversed sharply lower as the release of the December FOMC meeting minutes appeared to confirm the Federal Reserve's recent hawkish pivot. Even before Wednesday's Fed minutes' release, 10-year Treasury yields had already moved from 1.51% to 1.64% this week and yields surged even higher as markets digested the minutes, with the 10-year crossing above 1.70% for the first time since October. The move higher in yields appears to be driven by speculation that the Fed could look to further hasten the pace of policy tightening in the coming months and the minutes from the December FOMC meeting likely amplify these concerns. At the December meeting, the minutes show several Federal Reserve members cited a stronger economy and labor market and also pointed to the potential upside risks in inflation as warranting tighter monetary policy in 2022. While markets had already moved towards pricing rate hikes this year, the Fed also appears to be considering if, how and at what pace it should look to reduce the size of its balance sheet and the sharp move higher in long-end bond yields this week likely reflects speculation that such a "quantitative tightening" could be on the table in 2022. Equity markets have reacted to the move higher in yields this week with rate-sensitive sectors, such as Real Estate and high-multiple growth stocks, underperforming sharply. On the flip side, Energy and Financials are still up 6.6% and 2.6% on the week, respectively. Looking ahead, expect investors to pay close attention to Friday's non-farm payrolls report and next week's CPI release. 4Q21 earnings season will also get underway late next week.
Record stimulus and a stronger-than-expected US reopening have accelerated the shift from early to mid-cycle, lifting equity markets to new all-time highs. The continued economic momentum in global trade, manufacturing, corporate earnings, and housing have set the tone for strong US economic growth; however, this backdrop has been increasingly priced into markets. Index-level valuations peaked at more than 22x forward earnings and history suggests valuation multiples will trend lower as earnings improve, supporting our base case year-end 2022 target of 4,400 for the S&P 500 and our bull case of 5,000. With higher expectations and a move into mid-cycle, investors should upgrade their portfolios by dialing back extreme positioning and allocating more exposure toward high-quality cyclicals and growth at a reasonable price. With a potential long-term infrastructure bill in progress and the unleashing of pent-up demand for services-related spending, the US faces a potential favorable outlook for economic growth and inflation possibly rebounding to a 2.5%-3% range over the coming years. However, optimal navigation of this new business cycle will require care as Treasury rates appear likely to move higher toward 2% in the next year, creating a headwind for long-duration assets. With regard to stocks, our preferences for quality and valuation support warrant allocating to international stocks with less expensive valuations, and cyclicals, including financials, which should benefit from the steeper yield curve. Dollar weakness is likely to continue as policy choices are debasing and relative growth outside the US becomes more compelling as the rolling global reopening continues. In fixed income, the challenge is two-fold: Generating sufficient income, while also preserving capital, requires a diversified and active exposure, with our preference toward a mix of high yield credit, preferreds, leveraged loans, 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