Wealth Management — October 21, 2022
What Happened in the Markets?
- The S&P 500 rose 2.4% Friday to close at 3,753. With the gains, the index has now fallen 21.3% year-to-date.
- Markets continue to react to mixed Q3 earnings releases as well as commentary from senior Fed officials. Today, Fed President Daly noted that it is now time to begin rate step-down discussions to 50 basis points (bp) or 25bp increments. Additionally, Japan intervened to support the Yen and the US Dollar rallied. Yields at the short end of the curve declined while the longer end rose. Two-year Treasury yields declined from yesterday's new cycle high to 4.47% today, while the 30-year Treasury rose to 4.33% (a high last seen in June 2011).
- All 11 S&P 500 sectors increased as Materials (+3.5%) and Financials (+2.9%) outperformed, while Communication Services (+0.9%) and Real Estate (+0.7%) lagged.
- By the 4 pm equity market close, WTI oil was slightly higher to $85.1 per barrel while the US Dollar Index declined to 111.8. The 10-year Treasury yield fell to 4.22%.
What to Watch Going Forward
- 3Q22 Earnings: Ninety-nine S&P 500 companies reported third quarter results so far with 72% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised by 4.5% while sales surprised by 1.2%, according to Bloomberg. For the S&P 500, bottom-up, blended 3Q22 earnings growth is anticipated to be +3.1% 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 3.5% y/y. By next week, 163 more companies are expected to report. 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 9% chance of a 100-basis-point hike (according to Bloomberg).
US Economic Releases
- 10/24: Chicago Fed National Activity Index
- 10/25: FHFA House Price Index, Conference Board Consumer Confidence
- 10/26: New Home Sales, MBA Mortgage Applications
- 10/27: GDP, Durable Goods Orders, Personal Consumption, Jobless Claims
- 10/28: Employment Cost Index, Personal Spending, PCE Deflator, University of Michigan Consumer 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 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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