Wealth Management — September 23, 2022
- The S&P 500 Index dipped 1.7% Friday to end the trading day well in bear-market territory at 3,693, just shy of its June 16, 2022 low of 3,667.
- As of the 4pm equity close, the average S&P 500 constituent fell 30% from 52-week highs and nearly 25% of the index met new 52-week lows. Meanwhile, the 10-year dipped to 3.69% and the 2-year increased to 4.20% (the highest since 2007). WTI oil declined 5.4% to $79 per barrel (a low last seen in January 2022) as fears of a hard landing in the US heightened and as the dollar met multi-year highs relative to other currencies due to the relative strength of the US economy.
- The fight against global inflation led many central banks to raise interest rates nearly 650 basis points this week, according to FactSet, showing a willingness to push ahead into an economic slowdown to win the battle. Meanwhile, Japan's decision to hold rates flat drove the need for currency intervention. Subsequently, today in the UK, the finance minister's announcement of significant tax cuts to stimulate growth led to growing concerns regarding the level of funding these measures require when rates are headed higher. UK markets responded with a sharp pull-back; the British pound tumbled to $1.09 (a 37 year low) while UK bond yields surged the most in years. Markets priced in a Bank of England rate increase of 100-basis-points in November, following the Bank of England's 50-basis-point increase yesterday.
- As the end of the third quarter nears, we believe U.S. equity markets will continue to weigh the effect of elevated inflation, higher rates, and slowing growth on corporate earnings and valuations.
- All 11 S&P 500 sectors declined, with Health Care (-0.5%) and Utilities (-1.2%) the relative outperformers, while Consumer Discretionary (-2.3%) and Energy (-6.7%) underperformed.
- Monetary Policy: This week Fed Chair Powell announced a 75-basis-point hike following the FOMC's rate meetings and reiterated that the committee "will keep at it until ... confident the job is done." The committee's "Summary of Economic Projections" showed that members anticipate that monetary policy will continue to be restrictive for some time as expectations for the fed funds rate remain well above the 2.0% target rate at least until 2025 and the timing of future rate cuts is not apparent. The committee's median fed funds rate projections are for 4.4% in 2022, 4.6% in 2023, 3.9% in 2024, and 2.9% in 2025. This suggests that there is the potential for additional hikes in November, December, and into 2023, at least until it is clear that inflationary pressures have eased. Currently, fixed income markets are pricing in an 83% chance of a 75-basis-point hike at the November meeting and an 89% chance of a 50-basis-point hike following the meeting in December. MS & Co.'s Ellen Zentner expects a 75-basis-point hike in November, 50-basis-point in December, and 25-basis point in January to a terminal rate of 4.625% in January. Zentner expects rates to remain at this level until December 2023 when a first rate cut of 25-basis-point may occur. Regarding the balance sheet reduction program, Fed Chairman Powell previously indicated that the run-off of the mortgage backed securities (MBS) portion would occur once the run-off is well underway. 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.
- Calendar: Durable Goods, New Home Sales, FHFA House Price Index, Conference Board Consumer Confidence (9/27); Pending Home Sales (9/28); GDP revision (9/29); Personal Income & Spending, Chicago PMI, University of Michigan Consumer Sentiment (9/30).
With the Fed poised to respond 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. Our June 2023 base case provides a target of 3,900 for the S&P 500. 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. With earnings revisions moving lower off the prior peak, investors should focus on risk management through quality factor exposure, defensiveness with regard to interest rate sensitivity, and attention to stock-specific valuations. We are moving to a position of maximum diversification by sector and market cap, with interesting ideas in Energy, Industrials, Materials, Health Care, Consumer Services, Financials, Utilities and Staples. While the US recovery matures, we see opportunities outside the US as relatively more attractive, especially given less expensive valuations and exposure to economic cyclicality. 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, preferreds, leveraged loans, and asset-backed securities, including select mortgage-backed, and dividend-paying stocks. Real assets such as gold, infrastructure, and real estate present an attractive opportunity as a portfolio ballast for income generation and as an inflation hedge.
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.