The 1% Move Report

Wealth Management — April 12, 2024

• The S&P 500 Index fell 1.5% Friday to end the day at 5,123.41, having gained 7.4% thus far in 2024. 
• Zero of the 11 S&P 500 sectors were higher on the day, as Utilities (-0.7%) and Consumer Staples (-0.9%) were the strongest-performing S&P 500 sectors, while Information Technology (-1.6%) and Materials (-1.8%) underperformed.
• By the 4:00 p.m. equity market close, the US 10-year Treasury yield decreased 7bp to 4.52%; WTI crude oil prices increased 0.6% to $85.52 per barrel; and gold decreased 1.2% to $2,344.14 per ounce.

• All S&P 500 sectors moved lower today as geopolitical concerns and the start of first quarter earnings season triggered a risk-off trade. Equity volatility picked up, with the VIX jumping to 18.0 its highest level in 2024.
• After Bloomberg reported that Israel is preparing for a potential direct attack this weekend, oil prices increased. Rising commodity prices may push inflation higher, particularly after this week’s hot CPI report already dashed hopes of a Fed rate in June. Import prices also rose more-than-expected, at 0.4% month-over-month.
  
• Consumers signaled concerns over higher inflation. According to today’s University of Michigan Consumer Sentiment report, one- and five-to-10-year inflation expectations rose to 3.1% and 3.0%, respectively, well above the Fed’s 2% target and potentially entrenching inflation expectations at a higher level.
  
• Additionally, large banks kicked off 1Q2024 earnings season today, beating estimates but offering a disappointing lack of guidance on greater net interest income (NII), despite futures market’s significant repricing of higher-for-longer rates.

• Despite today's outsized move, the GIC recommends reducing exposure to US consumer discretionary stocks in favor of a barbell of industrial cyclicals (materials, energy, infrastructure and industrials), capital-market-leveraged financials and defensives (utilities and REITs). Today’s move does not meaningfully impact the GIC’s outlook. 
• Please find more information on the GIC's tactical positioning on the next two pages and reach out to your Morgan Stanley Financial Advisor to discuss portfolio strategies. For long-term investors, we caution against making substantial strategy changes based on short-term volatility. 

US: We remain uncertain that forward earnings estimates are accurately discounting the most recent developments of a strong US dollar, rising oil prices, maturing US fiscal stimulus and an increasingly tapped-out US consumer. Additionally, we expect that Fed actions in 2024 may result in a “higher-for-longer” rate scenario. Our preference is for defensive and secular-growth equities with quality balance sheets.

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: Recent softness in China, including macro uncertainty and deflationary pressures, along with growing opacity around policy direction, have caused concern for the country’s growth path. With global growth concerns potentially mounting, we have neutralized a previous overweight to emerging markets.

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. However, local currencies have recently weakened against a strengthening US dollar. Moreover, our benchmarks and tactical asset allocation models continue to allocate 0% to this asset class.

Inflation-Protected Securities: TIPS’ real 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 benchmarks and tactical asset allocation models 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 is currently limited upside and much downside to invest in riskier products, given the current market environment. Moreover, our benchmarks and tactical asset allocation models 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.

Commodities: Global central banks have successfully brought commodity prices back to late-2021 levels, albeit with a modest rally in the third quarter of 2023. 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.

Dallas Federal Manufacturing Index is released every month. It reflects overall business conditions and activity in the Texas' manufacturing sector.

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.