Wealth Management — October 18, 2022
- The S&P 500 rose 1.2% Tuesday to close at 3,721 as 89% of the index's constituents were higher on the day. With the gains, the index has now fallen 21.9% year-to-date.
- Despite elevated global inflation and monetary tightening, a number of companies provided positive commentary during third quarter conference calls. A few Financials and Health Care companies reported earnings surprises to the upside while a Leisure Products company disappointed today. Additionally, Atlanta Fed President Bostic reiterated the need to control inflation for maximum employment despite the "short-run pain".
- All 11 S&P 500 sectors increased as Industrials (+2.4%) and Materials (+1.9%) outperformed, while Health Care (+0.6%) and Communication Services (+0.5%) lagged.
- By the 4 pm equity market close, WTI oil fell to $83.1 per barrel while the US Dollar Index remained stable. The 2-year Treasury yield approached 4.43% and the 10-year Treasury yield declined below 4.0%.
- 3Q22 Earnings: Forty-five S&P 500 companies reported third quarter results so far with 73% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised by 3.6% while sales surprised by 0.8%, according to Bloomberg. For the S&P 500, bottom-up, blended 3Q22 earnings growth is anticipated to be +2.8% 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 3.9% y/y. Forty-nine 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 points may occur. MS & Co. believes a 75-basis-point hike could be possible in December 2022 if core services remain under pressure. The balance sheet reduction program doubled in September. 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).
- Industrial Production rose 5.3% YoY (+0.4% MoM) in the month of September to 105.2 as 74% of the major industry groups showed increases compared to a year ago despite high inflation and concerns about slowing economic growth. Motor Vehicles and Mining showed the largest gains compared to a year ago (+19.4% and 11.1%, respectively) while Textile and Product Mills (-5.4% YoY) showed the largest declines. Supply chain improvements and backlogs in demand helped motor vehicle production.
- Capacity Utilization of 80.3% showed labor and supply constraints eased in the month of September compared to 80.1% last month, 77.4% last year, and the 79.6% average since 1972.
- NAHB Housing Market Index sentiment declined further in October as home prices rose, mortgage rates increased to 7%, and building material supply chain constraints continued to dampen demand. The index decreased to levels last seen in May 2020.
- 10/19: US Housing Starts, US Building Permits
- 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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