Wealth Management — May 4, 2022
- The S&P 500 Index ended Wednesday 3.0% higher to close at 4,300 after the FOMC's announcement of future rate hikes and the start of quantitative tightening (balance sheet reductions). The index is now down 9.8% year to date.
- Following today's 50 basis-point hike announcement, Chair Powell noted that additional 50 basis-point hikes "should be on the table" for the FOMC's meetings in June and July. Additionally, Chair Powell said that a hike of "75 basis-points is not something the committee is actively considering." What seemed to be immediately following these comments, equities rallied sharply and the yield curve steepened as short-term rates experienced a large decline.
- All eleven S&P 500 sectors were higher on the day, with Energy (+4.1%) and Communication Services (+3.7%) outperforming the broad market while Real Estate (+1.1%) and Consumer Staples (+2.2%) lagged.
- As of the 4pm equity market close, yields were lower, particularly at the front end; 2-year Treasury yield was near 2.63%, and the 10-year Treasury yield was around 2.92%. WTI oil prices gained 5.5% to close near $108 as the European Union (EU) provided a timeline for their ban on Russia crude and refined products.
- Monetary Policy: Today, 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. Chair Powell stated that the FOMC unanimously voted to hike rates 50 basis-points today and guided to "ongoing 50 basis-point increases in the target rate at the next couple of meetings." Additionally, reductions to the $9 trillion Federal Reserve balance sheet will begin on June 1 when $47.5 billion of securities will be removed each month for the next three months (with caps on the amount of mortgage-backed securities and Treasury securities removed each month). These reductions will then increase to $95 billion per month. Fed Chair Powell stated that "the economy is strong and well positioned to handle tighter monetary policy." Currently, futures markets are pricing in 7.7, 25-basis-point hikes in the forward curve for the U.S., down from 10.2 hikes as of yesterday's close.
- Q1 Earnings: First quarter earnings season is nearly three-quarters over as 74% of the S&P 500 constituents reported results thus far (368 companies) and 69 more are expected by the end of this week. For the S&P 500, 79.9% of the companies that reported beat 1Q22 earnings expectations as blended earnings growth for the S&P 500 companies is running at 9.7% year-over-year, according to Refinitiv. Strong 1Q earnings growth continues to be expected from the Energy sector and a deceleration in earnings growth is anticipated from the Financials, Communication Services, and Consumer Discretionary sectors. During 1Q22 earnings calls, investors are closely monitoring forward guidance as well as the vulnerability of margins, earnings and valuations due to headwinds from higher input costs and deteriorating demand.
- Economic Releases: The U.S. trade balance showed the U.S. relied more on imports than expected during the first quarter while exports reached a record. This significant widening in net exports influenced the level of 1Q22 GDP which shrunk at an annual pace of 1.4%. The gap between the import of goods and services trade grew 22.3% in the first quarter.
- Calendar: Jobless Claims, Productivity & Costs (5/5), Employment Situation (5/6).
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 base case provides a year-end 2022 target of 4,400 for the S&P 500 while our bear case of 3,900 is still in play, especially as technicals and sentiment wrestle toward capitulation around the new regime. Our bull case of 5,000 corresponds to a view that rising rates and higher policy uncertainty demands lower price/earnings ratios, and this forecast embeds an estimate of 18x forward earnings, despite a forecast for earnings growth of 10%-12% in 2022. 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.