Wealth Management — February 21, 2023
What Happened in the Markets?
- The S&P 500 Index declined 2.0% Tuesday to 3,997.36. The index is now up 4.1% year to date.
- Each of the 11 S&P 500 sectors dipped as Energy (-0.3%) and Consumer Staples (-0.3%) outperformed while Information Technology (-2.4%) and Consumer Discretionary (-3.3%) lagged the index.
- With last week's inflation data upside surprises, investors and corporate management teams have been considering the implications of higher rates for longer and an uncertain economic outlook. Today, during quarter-end conference calls, management teams guided lower as they noted decelerating orders, increasing spending on wages, and difficulty in forecasting the impact of higher rates on consumer demand. Corporate profits remain near historic highs yet Fed tightening does not typically flow through to the economy until nine to 12 months later. The Fed first started raising rates in March 2022.
- The FOMC's meeting minutes from the committee's January 31 to February 1, 2023, meeting will be released tomorrow.
- As of the 4pm equity market close, WTI oil fell -0.2% to $76.16. Treasury yields rose across the curve, with the 10-year Treasury yield up to 3.95%.
S&P 500 Price vs 50, 100, 200 Daily Moving Averages
- 4Q22 Earnings: As of the market close, 417 S&P 500 companies reported fourth quarter results with 68% of them beating earnings expectations. In aggregate, for the companies that reported, earnings surprised to the upside by 2.0% while sales surprised by 1.9%, according to Bloomberg. For the S&P 500, bottom-up, blended 4Q22 earnings growth is anticipated to be -2.8% y/y even as earnings from Energy and Industrials companies are growing 59.3% and 42.0% y/y, respectively, according to Refinitiv. Excluding Energy, fourth quarter earnings are expected to be down 7.0% y/y. Looking forward, the Street currently anticipates the S&P 500 Index will see earnings decline 6.3% y/y in 1Q23 and dip 1.9% y/y for 2023. We believe investors have not yet priced in softening corporate earnings.
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 US dollar against a subset of the broad index currencies that circulate widely outside the US.