Wealth Management — October 4, 2022
What Happened in the Markets?
- The S&P 500 Index rose 3.1% Tuesday to close at 3,791, 5.7% higher than last Friday's bear-market low. Ninety-nine percent of the S&P 500's 503 constituents improved on the day. With the rally, the index is now down 20.5% year-to-date.
- Stocks surged for the second day in a row as investors debated if central banks around the world would choose to pivot from large rate increases. This followed the report that showed US job openings declined in August, the Royal Bank of Australia's announcement that it was hiking rates less than economists anticipated (25-basis-points), and expectations that the People's Bank of China (PBOC) may not make any additional rate cuts. Meanwhile, Federal Reserve officials emphasized that the inflation battle will take time.
- The Organization of the Petroleum Exporting Countries and its allies (including Russia) (OPEC+) is set to meet tomorrow to discuss supply cuts. There is potential for production to be reduced as much as two million barrels a day (per Bloomberg). This helped the WTI oil price rally to continue (up nearly 13% in just over a week).
- As of the 4pm equity market close, the 10-year and the 2-year Treasury yields remained at 3.64% and 4.11%, respectively while the US Dollar Index declined 1.5% to $110.1.
- All 11 S&P 500 sectors improved, with Energy (+4.3%) and Financials (+3.8%) the relative outperformers, while Real Estate (+1.6%) and Consumer Staples (+1.5%) underperformed.
What to Watch Going Forward
- 3Q22 Earnings Preview: A number of Financial companies are set to kick-off 3Q22 earnings season next week. For the S&P 500, bottom-up, 3Q22 earnings growth is anticipated to be 4.5% y/y (-2.0% ex-Energy), with five of the eleven sectors anticipating y/y growth (including +118%y/y growth for the Energy sector), according to I/B/E/S data from Refinitiv. During company 3Q22 earnings calls, investors will be monitoring forward guidance as well as the impact of elevated inflation, higher rates, and slowing growth on margins, earnings, and valuations.
- Monetary Policy: Following the September FOMC meeting, Fed Chair Powell announced a 75-basis-point 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 in November, 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 at this level until December 2023 when a first rate cut of 25-basis-points may occur. While the balance sheet reduction program doubled earlier this month, during this week's meeting, Fed Chair Powell indicated that MBS sales are not expected any time soon.
- Economic Data Today:
- JOLTS - In the month of August, the number of job openings in the US declined to 10.5 million, lower than economists expected. The lighter demand provides the potential for less wage pressure and comes as a welcome sign for the Fed.
- Calendar: ISM Services (10/5); Employment Situation (10/7).
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 2023 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 2023 bear case of 3,350 considers a slowdown in earnings growth rate, margin pressure, sticky inflation and a recession. Our June 2023 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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