Wealth Management — April 27, 2023
What Happened in the Markets?
- The S&P 500 Index rose 2.0% Thursday to end the day at 4,135.35, 7.7% higher year to date.
- All 11 S&P 500 sectors rose on the day, as Communication Services (+5.5%) and Consumer Discretionary (+2.8%) outperformed the S&P 500 Index, while Health Care (+0.5%) and Energy (+0.4%) underperformed.
- By the 4pm equity market close, the US 10-year Treasury yield rose 7 basis points to 3.52%, while WTI oil increased 0.7% to $74.83 per barrel.
- Today brought the busiest day thus far for S&P 500 1Q23 earnings calls, with earnings coming in ahead of expectations in every sector, including double-digit surprises in Industrials, Materials, Energy, and Communication Services. Some companies reported better-than-feared results, while noting pricing power strength and strong orders, including short-term inventory re-stocking of machinery equipment and semiconductor chips. The management team from a heavy equipment manufacturer highlighted the potential for dealer destocking during the remainder of 2023, with expectations for dealer inventories to remain comparable to the levels seen at the end of 2022. Interestingly, MS & Co.'s analysts believe that foundry capacity utilization is currently low, with a similar level of capacity utilization expected for the next 12 months. Thus, the semiconductor inventory build may be the result of "strategic planning."
- Additionally, the 1Q23 Gross Domestic Product (GDP) report showed continued economic slowing due to lower than expected contributions from inventories, consumption, and business investment, despite accelerating consumer spending. The 1Q23 Real GDP report showed 1.1% growth, below economists' expectations of 1.9%. MS & Co.'s Ellen Zentner expects the tighter monetary policy and banking pressures to lead to "significant slowing into 2Q23," to -0.4%.
S&P 500 Price vs. 50, 100, 200 Daily Moving Averages
- 1Q23 Earnings - As of last Friday, analyst expectations for the S&P 500 Index's 1Q23 share weighted earnings growth showed a deterioration of 7.3% year-over-year (y/y) on 2.3% y/y revenue growth. This included estimates for earnings declines in seven sectors, and revenue declines in three sectors. The most significant declines in earnings were expected in the Materials (-33.8% y/y), Health Care (-20.6% y/y), Information Technology (-14.8%), and Communication Services (-13.2% y/y) sectors, according to Bloomberg. With nearly 55% of the S&P 500's market cap reported thus far, 82% have reported earnings ahead of analysts' expectations. In aggregate, for the companies that reported 1Q23, sales and earnings are higher than analysts' expectations by 2.2%, and 6.6%, respectively, with the largest earnings surprises being seen in the Consumer Discretionary, Materials, and Energy sectors. Seven S&P 500 companies will report earnings tomorrow, and another 165 next week. During company 1Q23 earnings calls, investors will be closely monitoring forward guidance for pricing and volumes as well as vulnerability of margins and earnings due to the current economic uncertainty, elevated inflation, volatile rate environment, tightening financial conditions, and slowing growth. Despite expectations for lower rates, plans for cost reductions across businesses, and resilient consumer spending, the likelihood of negative operating leverage remains as companies navigate pricing power. We believe earnings forecasts remain too high and equities are not pricing in additional pressures from a soft landing or a recession, which could lead to further earnings cuts. We recommend managing volatility through a combination of maximum diversification and active risk management.
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 remains intact. Corporate earnings revisions moved lower over the course of 2022, suggesting downside to forward earnings growth. We recommend investors focus on risk management through quality cash flows, defensiveness, and attention to stock-specific valuations. We suggest rebalancing portfolios and tax-loss harvesting during bear market rallies. In fixed income, the challenge is two-fold: generating sufficient income, while also preserving capital, given the potential for higher yields amid ongoing inflation. 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 higher real rates, falling operating leverage and the strong US dollar.
For US equities, the MS & Co. US Equity Strategy team sees the potential for further equity downside in the early part of 2023, given their base-case expectations of $195 for 2023E earnings, well below current consensus levels. Their 2023E S&P 500 base case provides a target of 3,900, based on 2024E earnings of $241. This scenario assumes that nominal top-line growth slows to the low single digits and that margins contract. Their 2023E bear case of 3,500 considers a severe earnings recession, margin pressure and a contraction of EPS growth. Their 2023E bull case of 4,200 corresponds to a mid-single-digit top-line growth rate and limited margin compression. This bull case forecast embeds an estimate of 16.7x MS & Co.'s forward 2024E earnings of $251.
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.