Wealth Management — May 11, 2022
- Despite a morning run 1.2% higher, the S&P 500 sold off through Wednesday afternoon to end the day down 1.6% to 3,935. The index has now declined 17.4% year-to-date, and is at its lowest level since the end of March 2021. More than 21% of the S&P 500 constituents are at 52-week lows.
- Headwinds remain from elevated inflation and a hawkish Federal Reserve. This morning's CPI release showed inflation persisted in the month of April, with the headline CPI up 8.3% annually (down from 8.5% last month and ahead of the consensus estimate of 8.1%). Additionally, Federal Reserve Atlanta President Bostic commented that he would "be supporting moving more" on rates if inflation remains high.
- Three of the 11 S&P 500 sectors increased in the session, with Energy (+1.4%) and Utilities (+0.8%) outperforming the broad market while Consumer Discretionary (-3.6%) and Information Technology (-3.3%) lagged.
- As of the 4pm equity market close, the 10-year Treasury yield fell 8 basis-points to 2.91%. WTI oil prices rose 5.3% to $105.
- CPI: Today's consumer price index (CPI) report showed inflation continued to rise ahead of expectations in the month of April, with Headline CPI up 0.3.% month to month. On an annual basis, the headline CPI rate was 8.3% year over year.
- Monetary Policy: Last week, Fed Chair Powell announced that 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. Fed Chair Powell stated that the FOMC unanimously voted to hike rates 50 basis-points last week 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") is set to begin 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 7.6, 25-basis-point hikes in the forward curve for the U.S., down from 10.2 hikes as of last Tuesday's close.
- S&P 500 Earnings: First quarter earnings season is nearly over as 91% of the S&P 500 constituents reported results thus far (452 companies) and seven more are expected by the end of this week. For the S&P 500, 76% of the companies that reported beat 1Q22 earnings expectations, while blended 1Q22 earnings growth for the S&P 500 companies is running at 10.4% year-over-year, according to Refinitiv. Investors will continue to monitor cost pressures and supply and demand drivers as a way to understand the level influence on earnings and revenues. Deteriorating demand and cost headwinds could lead to margin compression and earnings growth rate deceleration through 2022 and into 2023.
- Calendar: PPI (5/12); UMich. Sentiment (5/13).
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 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 being found 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.
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