Wealth Management — May 18, 2022
- The S&P 500 plunged on Wednesday, falling 4.0% to close at 3,924. With the sell-off, the index is now down 17.7% year to date. Ninety-eight percent of S&P 500 members finished lower in the session.
- After a 2% rally in the S&P 500 on Tuesday, equity markets reversed sharply lower on Wednesday. Economic growth concerns and lackluster earnings reports from a number of large retail companies were the main catalysts for downside in the session. In particular, retailer operating margins were squeezed by continued input and labor cost pressures. Consumer Staples and Consumer Discretionary were the main victims of this negative development, with both sectors recording the largest daily sell-offs since the March 2020 COVID-induced plummet. Cross-asset leadership was risk-off, with defensive equities relatively outperforming, gold moving higher and interest rates across the curve rallying.
- All 11 S&P 500 sectors were lower in the session, with Utilities (-1.0%) and Health Care (-2.6%) outperforming the broad market while Consumer Staples (-6.4%) and Consumer Discretionary (-6.6%) lagged.
- As of the 4pm equity market close, the 10-year Treasury yield declined to 2.89%. WTI oil prices also fell to $109 per barrel, while the US Dollar Index increased.
- 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") 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 8.0, 25-basis-point hikes in the forward curve for the U.S., down from 10.2 hikes on May 3.
- S&P 500 Earnings: First quarter earnings season is nearly over as 93% of the S&P 500 constituents reported results thus far (465 companies). Twenty-one companies are expected to report later 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 9.1% year-over-year, according to FactSet. 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: Existing Home Sales, Leading Index (5/19).
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.