Wealth Management — October 25, 2022
What Happened in the Markets?
- The S&P 500 rose 1.6% Tuesday to close at 3,859, 7.9% higher than the recent low on October 12. With the gains, the index has now fallen 19.0% year-to-date.
- Ten of the 11 S&P 500 sectors increased Tuesday as Real Estate (+4.0%) and Materials (+2.5%) outperformed, while Health Care (+0.8%) and Energy (-0.1%) lagged.
- Third quarter 2022 earnings results have been mixed so far as 129 S&P 500 constituents announced single-digit surprises for sales and earnings. However, margin deterioration has been more than anticipated. Nearly a quarter of the constituents within the S&P 500 released third quarter earnings through 4pm today, and another 136 are anticipated to report by the end of the week. Earnings announcements from a few mega-cap technology stocks are anticipated after today's close.
- While the energy crisis continues in Europe and Asia, Permian Basin natural gas prices declined below zero following a surge in output.
- The UK appointed a new Prime Minister; the US dollar weakened relative to the British pound.
- By the 4 pm equity market close, WTI oil was slightly higher, at $85 per barrel, while the US Dollar Index dropped to 110.9 and Treasury yields rallied. The 10-year US Treasury yield and 2-year Treasury yield returned to 4.08% and 4.46%, respectively.
What to Watch Going Forward
- 3Q22 Earnings: One hundred twenty-nine 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 4.7% while sales surprised by 1.5%, 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 +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 the end of this week, 136 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 2 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.
US Economic Releases
- FHFA House Price Index and S&P CoreLogic Case-Shiller Home Price Index showed home prices fell m/m in August.
- Conference Board Consumer Confidence declined more than expected for the month of October as consumers showed concerns over rising costs and slowing economic growth.
- 10/26: New Home Sales, MBA Mortgage Applications
- 10/27: 3Q 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 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.
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