Wealth Management — October 13, 2022
What Happened in the Markets?
- The S&P 500 snapped a six day losing streak Thursday, rising 2.6% to 3,670. With the gains, the index has fallen 23.0% year-to-date.
- Following a higher-than-expected CPI release this morning, interest rates rose sharply across the curve, the US Dollar Index strengthened, and equity markets sold off as markets priced a continued hawkish monetary policy backdrop. However, stocks posted strong rebounds off the early morning intraday lows as Treasury bonds pared losses. For equities, perhaps the rally was a byproduct of oversold conditions, given that the S&P 500 made new bear market lows early in the session and recorded declines in six consecutive prior trading days. Nonetheless, sticky inflation and a slowing economy remain headwinds as we start 3Q22 earnings season.
- All 11 S&P 500 sectors rose, with cyclical sectors leading as Financials (+4.1%) and Energy (+4.1%) outperformed, while Consumer Staples (+1.6%) and Consumer Discretionary (+1.0%) lagged.
- By the 4 pm close, WTI oil climbed to $89, while the US Dollar Index modestly declined. The 2-year Treasury yield rose to the highest level since 2007 at 4.47%. The 10-year Treasury yield rose to 3.95%.
What to Watch Going Forward
- 3Q22 Earnings Preview: A number of Financial companies kicked-off 3Q22 earnings season this week and the majority of the S&P 500 constituents are expected to report through the week of October 31. For the S&P 500 Index, according to Bloomberg, share-weighted bottom-up 3Q22 earnings growth is anticipated to be 2.6% y/y (-3.9% ex-Energy), with five of the 11 sectors anticipating y/y improvement. During company 3Q22 earnings calls, investors will be monitoring forward guidance as well as the impact of a strong US dollar, elevated/sticky inflation, higher rates, the shift from goods to services, the inventory glut, and slowing demand conditions. We expect these headwinds to weigh on revenues, margins, earnings, and valuations.
- Monetary Policy: Following the September FOMC meeting, Fed Chair Powell announced a 75-basis-point (bp) hike and reiterated that the committee "will keep at it until ... confident the job is done." MS & Co.'s Ellen Zentner expects a 75-basis-point hike at the November 2nd meeting, 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-basis-points may occur. MS & Co. believes a 75 bp hike could be possible in December if core services remain under pressure. While the balance sheet reduction program doubled in September, Fed Chair Powell indicated that MBS sales are not expected any time soon during last month's meeting. Following today's CPI print, the odds of a 75 basis-point hike at the November FOMC meeting are now 100%, and a 15% chance of a 100 basis point hike (according to Bloomberg).
US Economic Releases
- Consumer Price Index (CPI) - Both headline and core CPI came in above expectations on Thursday. Headline CPI rose 8.2% YoY (8.1% estimate), while core increased 6.6% YoY (6.5% estimate). Additionally, the month-over-month increases surprised to the upside. Shelter inflation continues to accelerate, the largest weight in the CPI basket, with Owners' Equivalent Rent rising to 6.7% YoY, the highest on record. Overall, the inflation print sent a hawkish ripple across markets as interest rates moved higher across the curve and rate hike expectations spiked.
- 10/14: Retail Sales, University of Michigan Sentiment
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 2023 S&P 500 base case provides a target of 3,900. 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 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.
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