Wealth Management — September 30, 2022
- The S&P 500 Index declined 1.5% Friday to end the third quarter of 2022 at a new bear market low of 3,586. With the sell-off, the index posted a third-quarter decline of 5.3% and is now down 24.8% year to date.
- The main drivers of weakness lately include slowing economic growth, a hawkish Federal Reserve, continued elevated inflation, and sharply higher interest rates. Additionally, higher inflation prints continue both in and outside the US. Today, the core PCE inflation release was above expectations while Eurozone inflation rose 10.0% y/y for the month of September. Energy gained nearly 41% y/y and Food prices rose 11.8% y/y in the Eurozone region.
- The final day of September brings an end to the third quarter. We believe US equity markets will continue to weigh the effect of elevated inflation, higher rates, and slowing growth on corporate earnings and valuations. According to Refinitiv, the expectation for 3Q22 S&P 500 earnings growth is 4.5% y/y (-2.0% ex-Energy), with five of the eleven sectors growing y/y (including +118%y/y growth for the Energy sector).
- Ten of the 11 S&P 500 sectors fell, with Real Estate (+1.0%) and Materials (-0.3%) the relative outperformers, while Utilities (-1.9%) and IT (-1.9%) underperformed.
- As of the 4pm equity market close, the 10-year Treasury yield rose to 3.80%. WTI oil fell to below $80 per barrel while gold rose to $1,662 per ounce.
- Monetary Policy: Earlier this month, 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:
- PCE Inflation: Headline PCE rose 6.2% y/y in the month of August while, excluding Food & Energy, PCE inflation gained 4.9%y/y, both in-line with MS & Co. expectations. Higher inflation was seen in goods and services.
- Personal Income & Spending: Nominal personal income improved, in-line with consensus, while compensation decelerated alongside slowing job growth. Nominal personal spending benefitted from strength in in services.
- Chicago PMI: Business activity, according to the Chicago PMI Index, dipped over the past month as declines were noted in employment, new orders, production, and backlogs while prices, inventories, and deliveries rose at a slower pace.
- University of Michigan Consumer Sentiment: Consumer sentiment for the month of September remained relatively unchanged compared with August.
- Calendar: ISM Manufacturing, Construction Spending (10/3); JOLTS (10/4); ISM Services (10/5); Employment Situation (10/7)
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.