Wealth Management — June 10, 2022
- The S&P 500 declined 2.9% on Friday to close at 3,901. With the sell-off, the index is now down 18.2% year to date.
- Stocks continued to weaken from the prior day's session on Friday as the US CPI reading came in above expectations at 8.6% YoY, a 40-year high. The 1.0% month over month increase was also above the 0.7% consensus forecast. As a result of the higher than expected print, cross-asset market volatility ratcheted higher. Treasury bonds sold off sharply, with 2-year rates up 25 basis points in the session, reaching the highest level since 2008. Equity market weakness was broad based, with all 11 sectors trading lower and 93% of S&P 500 constituents recording a negative return. In addition, market pricing of future Federal Reserve interest rate hikes moved towards prior highs, with futures markets now expecting a 50 basis-point hike at the next three meetings. We anticipate volatility to remain high going into next week's FOMC meeting.
- All 11 S&P 500 sectors were lower, as Consumer Staples (-0.3%) and Utilities (-0.8%) outperformed the broad market while Information Technology (-3.9%) and Consumer Discretionary (-4.2%) lagged.
- As of the 4pm equity market close, the 10-year Treasury yield rose to 3.15%, while 2-year rates moved 25 basis points higher as the yield curve flattened. WTI oil declined to just above $120 per barrel, while gold was up over 1% at $1,870 per ounce. The US Dollar Index strengthened modestly in the session.
- Economic Data: US CPI rose more than anticipated on Friday, up 8.6% YoY and 1.0% MoM. The underlying inflation pressures were broad based in the report, with both goods and services inflation accelerating. This included upside in car and apparel prices, as well as travel-oriented areas. Shelter prices also continued their ascent, with rent inflation rising to the highest level since 1987. In other economic data reported Friday, consumer sentiment fell sharply, with the University of Michigan Consumer Sentiment index declining to a record low.
- Monetary Policy: The FOMC sees a path to a "softish landing" as the labor market and the financial conditions of households and businesses are strong enough to provide "a good chance to restore the economy without a recession." This path includes an expeditious move in policy rates. During the May meeting, the FOMC unanimously voted to hike rates 50 basis points and guided to "ongoing 50-basis-point increases in the target rate at the next couple of meetings." Additionally, Fed Chair Powell said that a hike of "75 basis-points is not something the committee is actively considering." Quantitative Tightening ("QT") began June 1. The reductions to the $9 trillion Federal Reserve balance sheet will occur within cap limits as $47.5 billion of securities will be removed each month for the next three months ($30 billion from Treasury securities and $17.5 billion from mortgage-backed securities). In September, the reductions will ramp to a maximum of $95 billion per month ($60 billion from Treasury securities and $35 billion from mortgage-backed securities). Currently, futures markets are pricing in 9.5, 25-basis-point hikes in the forward curve for the U.S., down from 10.2 hikes on May 3.
- Calendar: NFIB Small Business Optimism, US PPI (6/14); FOMC Meeting, MBA Mortgage Apps, Retail Sales, NAHB Housing Market Index (6/15); Housing Starts, Jobless Claims (6/16); Industrial Production (6/17).
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.