Wealth Management — October 28, 2022
What Happened in the Markets?
- The S&P 500 rallied 2.5% Friday to close at 3,901, snapping a two-day losing streak. With the gains, the index has now fallen 18.2% year-to-date.
- Ten of the 11 S&P 500 sectors increased Friday as Information Technology (+4.5%) and Communication Services (+3.0%) outperformed, while Energy (+0.6%) and Consumer Discretionary (-0.3%) lagged.
- It was a volatile week for equity markets, with Q3 earnings the biggest driver of equity returns. Despite several mega cap technology companies missing analyst expectations the past few sessions, markets were able to remain resilient going into the weekend. In fact, with Friday's gains, the S&P 500 recorded two consecutive weeks of positive returns for the first time since August.
- While continued Q3 earnings will remain in the forefront, the results of next week's FOMC meeting will also be in focus. Fixed income markets are currently fully pricing in another 75 basis-point hike, which would be the fourth such hike in a row. The ISM PMIs, durable goods orders and October jobs reports will also be closely watched economic data next week.
- By the 4 pm equity market close, WTI oil was lower, at $88 per barrel, while the US Dollar Index was modestly higher. The 10-year US Treasury yield and 2-year Treasury yield rose to 4.00% and 4.41%, respectively.
What to Watch Going Forward
- 3Q22 Earnings: So far, 263 S&P 500 companies reported third quarter results with 71% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised by 3.8% while sales surprised by 1.8%, 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 +4.1% 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 next week, 164 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%, according to Bloomberg.
US Economic Releases
- The Employment Cost Index increased by 1.2% in the 3Q, matching consensus estimates. It has now fallen from the all-time highs of 1.4% for two consecutive quarters. Wages and salaries increased 1.3% as wages in goods and services producing industries were lower than last quarter, adding to inflationary pressures. Public sector workers saw wages lag the private sector.
- Pending home sales were down 10.4% MoM, below the expectations of -4.0%. It was the largest monthly decrease since April 2020. Housing markets continue to feel the pressure from the sharp rise in mortgage rates.
- Headline Personal Consumption Expenditures (PCE) inflation rose 0.3% MoM and 6.2% YoY (consistent with last month), signaling no changes in inflationary pressures.
- The University of Michigan Sentiment Index increased to 59.9 in the month of October, slightly above expectations.
- 10/31: Dallas Fed Manufacturing Activity
- 11/1: S&P Global US Manufacturing PMI, JOLTS Job Openings, ISM Manufacturing
- 11/2: ADP Employment Change, FOMC Rate Decision
- 11/3: Jobless Claims, ISM Services, Durable Goods Orders
- 11/4: Employment Situation
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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