Wealth Management — November 10, 2022
What Happened in the Markets?
- The S&P 500 rallied 5.5% Thursday to close at 3,956. Ninety-six percent of index constituents had positive returns. With the gains, the index has now fallen 17.0% year-to-date.
- All 11 S&P 500 sectors increased Thursday as Information Technology (+8.3%) and Real Estate (+7.7%) outperformed while Consumer Staples (+2.4%) and Energy (+2.2%) lagged.
- Thursday's CPI report showed that inflation in October was below the consensus expectations from both a headline and core perspective, causing a sharp rally across financial assets. US Headline CPI reported at 7.7% YoY, and 0.3% MoM, both below the estimates of 7.9% and 0.5%, respectively. Treasury bonds rallied, with 10-year yields dropping 25 basis points in the largest one-day fall since March 2020. This helped interest rate-sensitive equities outperform as growth and technology stocks led market gains. Commodities also saw strong upside moves as the US Dollar Index declined 2%, the largest daily drop since 2015.
- By the 4 pm equity market close, WTI oil was modestly higher to $86 per barrel. The US Dollar Index fell 2.3%, while gold improved 2.8% to $1,750 per ounce. Meanwhile, the 10-year US Treasury yield declined to 3.82% while the 2-year Treasury yield decreased to 4.33%. Bond markets are closed Friday in observance of Veteran's Day.
What to Watch Going Forward
- 3Q22 Earnings: As of market close Thursday, 461 S&P 500 companies reported third quarter results with 69% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised by 2.9% while sales surprised by 2.6%, according to Bloomberg. Nonetheless, increasing cost pressures are evident as margin expectations are now below preseason forecasts. For the S&P 500, bottom-up, blended 3Q22 earnings growth is anticipated to be +4.3% y/y as earnings from Energy companies are driving much of the growth, according to Refinitiv. Excluding Energy, third quarter earnings are expected to be down 3.4%. By the end of next week, 15 more companies are expected to report.
- Monetary Policy: Following the November FOMC meeting, Fed Chair Powell announced a fourth consecutive 75-basis-point (bp) hike and reiterated that "there is still a way to go to get to a sufficiently restrictive level of monetary policy" that will allow for inflation to return to 2% over time. Ongoing rate increases are likely and there will be a discussion at the next meeting on the need for another 75-basis-point hike, or if it is possible to moderate the pace of increases. Nonetheless, Fed Chair Powell emphasized that the discussion on how long to keep policy restrictive is most important and that it is premature to think about a pause in rate hikes. With core services inflation still rising and goods inflation higher than the Fed anticipated at this point in time, the clarity on when inflation will moderate sustainably is not apparent. During the Q&A session, Fed Chair Powell noted that "a soft landing is still possible, although the window has narrowed." MS & Co.'s Ellen Zentner expects a 50-basis-point hike in December, and a 25-basis-point hike in January 2023, to a terminal rate of 4.625% in January. Additionally, she anticipates that rates will remain steady at the implied 4.625% level until December 2023 when a first rate cut of 25 bp may occur. Odds of a 50 bp hike at the December FOMC meeting are 99% while odds of a 75 bp hike fell to 0% from 26% yesterday, according to Bloomberg.
US Economic Releases
- 11/11: University of Michigan Sentiment Index
The Global Investment Committee’s Outlook
With the Fed responding 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. Corporate earnings revisions are moving lower, and valuations remain rich, especially relative to the 10-year real interest rate. We recommend that investors focus on risk management through quality cash flows, defensiveness with regard to interest rate sensitivity, and attention to stock-specific valuations. Bear market rallies should be used for rebalancing and tax-loss harvesting. 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 diversified and active exposure, with our preference for core investment grade fixed income and dividend-paying stocks. Consider revisiting positioning in long-duration/growth equities, where there may not be adequate compensation for the risks of rising real rates, falling operating leverage and the strong US dollar.
For US equities, our June 2023E S&P 500 base case provides a target of 3,900. This scenario assumes earnings and revenue growth decelerate due to high cost pressures in a slowing growth environment. Our June 2023E bear case of 3,350 considers a slowdown in earnings growth rate, margin pressure, sticky inflation and a recession. Our June 2023E 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 MS & Co.'s forward June 2024E earnings.
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.
Important note regarding economic sanctions. This event may involve the discussion of country/ies which are generally the subject of selective sanctions programs administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries or multi-national bodies. The content of this presentation is for informational purposes and does not represent Morgan Stanley’s view as to whether or not any of the Persons, instruments or investments discussed are or may become subject to sanctions. Any references in this presentation to entities or instruments that may be covered by such sanctions should not be read as recommending or advising on any investment activities involving such entities or instruments. You are solely responsible for ensuring that your investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.