Wealth Management — September 29, 2022
- The S&P 500 Index declined 2.1% Thursday to a new bear market low of 3,641, erasing all of the prior day's gains. With the sell-off, the index is now down 23.6% year to date.
- Following yesterday's relief rally on the back of sharply lower rates, markets turned sour again. The main drivers of weakness lately include slowing economic growth, a hawkish Federal Reserve, continued elevated inflation, and sharply higher interest rates. To close out the week, markets will gauge the health of the US consumer with the release of the University of Michigan Sentiment Index report.
- As the end of the third quarter nears, we believe US 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 fell, with Energy (-0.1%) and Health Care (-0.9%) the relative outperformers, while Consumer Discretionary (-3.4%) and Utilities (-4.1%) underperformed.
- As of the 4pm equity market close, the 10-year Treasury yield rose to 3.77%. WTI oil fell to below $82 per barrel while gold was flat at $1,660 per ounce.
- Monetary Policy: Last 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." 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. Zentner expects rates to remain at this level until December 2023 when a first rate cut of 25-basis-points 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.
- Economic Data Today:
- Jobless Claims: Fell to 193,000 versus the consensus of 215,000, the lowest level since April of last year.
- Personal Consumption: Second quarter third revision rose to 2.0% versus the prior revision of 1.5%.
- Calendar: Personal Income & Spending, Chicago PMI, University of Michigan Consumer Sentiment (9/30).
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.