Wealth Management — October 17, 2022
- The S&P 500 rallied 2.6% Monday to close at 3,678 as 95% of the index's constituents were higher on the day. With the gains, the index has now fallen 22.8% year-to-date.
- All 11 S&P 500 sectors increased as Consumer Discretionary (+4.2%) and Real Estate (+3.9%) outperformed, while Energy (+1.2%) and Consumer Staples (+1.1%) lagged.
- By the 4 pm equity market close, WTI oil fell to below $86 per barrel while the US Dollar Index modestly declined. The 2-year Treasury yield fell to 4.45% and the 10-year Treasury yield was flat at 4.01%.
- Volatility continues to grip Wall Street, with the S&P 500 rebounding today after Friday's 2.4% loss. Monday's move higher was potentially lifted by better-than-expected 3Q22 earnings reports from many large cap banks on Friday, improved sentiment in the UK following the abandonment of the corporate tax cut program, and strong technical support. To that end, the S&P 500 tested a key technical level last Friday, the 200-week moving average, and has since bounced off that highly watched level.
- Q3 earnings will be the main focus this week, with nearly 15% of S&P 500 market cap scheduled to report results.
- 3Q22 Earnings: Thirty-eight S&P 500 companies reported third quarter results so far with 71% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised by 3.8% while sales surprised by 0.8%, according to Bloomberg. For the S&P 500, bottom-up, blended 3Q22 earnings growth is anticipated to be +3.6% 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 3.1% y/y. Sixty-two more companies are expected to report this week. 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, 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-basis-point may occur. MS & Co. believes a 75-basis-point 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. Odds of a 75-basis-point hike at the November FOMC meeting are now 100%, and a 12% chance of a 100-basis-point hike (according to Bloomberg).
- Empire Manufacturing - Reported at -9.1, lower than the consensus forecast of -4.3 for the month of October.
- 10/18: Industrial Production, NAHB Housing Market Index
- 10/19: Housing Starts
- 10/20: Leading Indicators, Existing Home Sales
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 decelerates 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 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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