The 1% Move Report

Wealth Management — September 15, 2023

• The S&P 500 Index fell 1.2% Friday to end the day at 4,450.32, having gained 15.9% thus far in 2023. 
• All of the 11 S&P 500 sectors were lower on the day, as Utilities (-0.5%), Real Estate (-0.5%), Industrials (-0.5%), Financials (-0.7%), Health Care (-0.7%), Consumer Staples (-0.8%), Materials (-1.1%), and Communication Services (-1.1%) outperformed the S&P 500 Index. Energy (-1.3%), Consumer discretionary (-1.9%), and Technology (-1.9%) underperformed.
• By the 4:00 p.m. equity market close, the US 10-year Treasury yield increased 4 bp to 4.33%; WTI crude oil prices increased 1.1% to $91.13 per barrel; and gold increased 0.6% to 1,922.59.
• The S&P 500 declined on a “quadruple-witching” day, with the expiry of four types of derivative contracts—equity index futures, equity index options, single-stock options and single-stock futures. These occurrences come four times each year.
• The Information Technology, Consumer Discretionary, and Communication Services sectors paced declines, reacting in part to higher yields across the US Treasury curve.
• The United Auto Workers (UAW) initiated a simultaneous strike against the Detroit three automakers—GM, Ford, and Stellantis—after failing to reach a wage-increase agreement prior to Thursday’s deadline.
• The VIX increased from its lowest closing level (12.82) since January 2020.
• Moreover, major US equity indices—the S&P 500, Russell 2000, and Nasdaq—will rebalance as of today’s close, often viewed as a catalyst for greater transaction volume. 

US: The Fed campaign on inflation is not yet over and while inflation is cooling, it remains off the 2% target. The risk of economic recession has increased modestly in 2023, and prospects for negative earnings revisions are rising as are headwinds to valuation multiples. We expect downside risk of 10% to 20%. 

International Equities (Developed Markets): The mix of high and sticky inflation, existential risks associated with Russia/Ukraine and the European Central Bank's position that it has limited tools to help suggest that the odds of recession are over 50%. Developed market exposure should skew toward commodities and materials exporters, especially those in the Asia/Pacific region, including Japan.

Emerging Markets: China's reopening and Quantitative Easing have pushed emerging markets to outperform since October, yet we still see considerable opportunity in the region. Moreover, we are opportunistically adding to positions there and in Latin America, which benefits from already tight central bank policy and commodity exporter windfalls. We remain overweight emerging markets with strengthening conviction, given currency dynamics and valuations.

US Investment Grade: While markets had aggressively priced the Fed's hawkish rhetoric, recent bank concerns have brought in pricing of rate cuts through early 2024. We are taking a more balanced risk-reward approach and have added to large underweight positions. With continued Quantitative Tightening ahead, execution risk remains elevated, as do the risks from sticky services inflation. However, bonds still offer decent relative value and the potential for portfolio hedging. Moreover, we expect equity-fixed income correlations to decrease in the event of an earnings recession.

International Investment Grade: Central banks’ hawkish pivots have prompted a material move in global nominal rates. While timing and catalysts are still hazy, negative-yielding debt has largely vanished in recent months. Prospects are brightening for fixed income investors, with opportunities to invest in local currencies that are expected to strengthen against the US dollar. Nevertheless, our benchmark and tactical asset allocation model continue to allocate 0% to this asset class.

Inflation-Protected Securities: TIPS yields have moved up, as realized inflation remains near a 40-year high and geopolitical uncertainties add pricing pressures. Even with real yields now positive, valuation is not compelling in comparison to US investment grade fixed income. Moreover, our benchmark and tactical asset allocation model continue to allocate 0% to this asset class.

High Yield: We have eliminated our exposure to the equity-like asset class to reduce equity beta of portfolios. High yield bonds rallied aggressively after the unprecedented provision of liquidity from the Fed and fiscal stimulus from Washington. However, there appears to be limited upside and much downside to investing in riskier products, given the current market environment. Moreover, our benchmark and tactical asset allocation model continue to allocate 0% to this asset class.

REITS: With real interest rates now positive and services inflation remaining quite sticky, we would need to be cautious and selective in adding to this asset class. For now, we remain underweight.

Commodities: Global central banks have successfully brought commodity prices back to late-2021 levels. Supply chains for goods have been close to restored, which has helped to relieve some pressures on inflation coming from industrial metals and auto parts. That said, structural disruption in energy and global agricultural commodities remains severe and may take multiple quarters to cure. Semiconductor trade has been down since the CHIPS Act was enacted.

Hedged Strategies (Hedge Funds and Managed Futures): The current environment appears constructive for hedge fund managers who are good stock-pickers and can use leverage and risk management to amplify returns. We prefer very active and fundamental strategies, especially high quality, low beta, low volatility and absolute return hedge funds.

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.