The 1% Move

Wealth Management — January 31, 2021

• The S&P 500 rallied and closed up % to XXXX.  The index is now down % year-to-date and down 5.4% from its 52-week high. 
• Investors continued to debate the levels of future Fed policy tightening alongside mixed 4Q21 earnings, persistent COVID-related economic supply chain pressures, energy related shocks and geopolitical tensions.  Additionally, recent economic data showed inventory building and a bit of a pull-back in new orders and consumer spending. 
• The S&P 500 Communication Services (+2.7%), Real Estate (+1.5%) and Utilities (+0.6%) sectors outperformed Wednesday, while Energy (-1.1%), Consumer Discretionary (-0.4%), and Financials (-0.3%) lagged.

4Q21 Earnings: So far 43% of the S&P 500 has reported earnings results with blended 4Q21 earnings growth running at 26% year over year. However, earnings revision breadth is trending down with cyclicals showing relative weakness. We expect to hear from an additional 67 companies by the end of this week. Fundamentals, growth, and guidance remain the focus.

Rates and the Fed: A data-dependent stage is set for rate hikes to begin in March as Chair Powell mentioned the potential for the Fed to hike at every meeting in 2022. Chair Powell's hawkish commentary noted that asset purchases will be phased out into March, securities will be allowed to roll off the balance sheet, and reductions will occur after rate hikes. Watch for yield curve steepening as a key success indicator for Fed policy. Earlier this week, Morgan Stanley Wealth Management Chief Investment Officer Lisa Shalett hosted a fireside chat with Morgan Stanley & Co. Research Chief U.S. Economist Ellen Zentner and Global Head of Macro Strategy Matthew Hornbach to discuss the Fed’s latest policy signals and the markets’ response. If you would like to listen to the discussion, please ask your Financial Advisor for "The Fed Has Spoken. Now What?”

Federal Policy: Watch for potential economic pressures from expiring tax credits and the looming exhaustion of pandemic related fiscal support that inflated individual savings accounts within the past year. Congress returns from recess this week with plans to address the stalled Build Back Better Act. In addition, we expect Congress to quickly enact a continuing resolution to avoid government shutdown, as the 2022 budget has yet to be confirmed. 

Calendar: Senate Nomination Hearings, ISM Services PMI, Durable Goods Orders (2/3); Nonfarm Payrolls/ Unemployment rate, Winter Olympics (2/4); NFIB Survey (2/8); CPI (2/10). Watch for evidence of a slowdown beyond Omicron pressures.

With the Fed poised to respond to 40-year highs in inflation through both rate hikes and balance sheet run-off in 2022, the GIC’s call for a 5%-15% correction in the indices remains intact. Our base case year-end 2022 target of 4,400 for the S&P 500 and our bull case of 5,000 corresponds to a view that rising rates and higher policy uncertainty demands lower price/earnings ratios and our forecast embeds an estimate of 18x forward earnings, despite a forecast for earnings growth of 10%-12% in 2022.  With earnings revisions peaking, short-term tactical investors should upgrade their portfolios by dialing back extreme positioning and allocating more exposure toward high-quality cyclicals, defensives and growth at a reasonable price. We barbell Financials and Energy with exposure to Utilities, Staples and Healthcare.  While the US recovery matures, we see opportunities outside the US as relatively more attractive especially given less expensive valuations and exposure to economic cyclicality.  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 a diversified and active exposure, with our preference toward a mix of cash/ultrashort duration, high yield credit, preferreds, leveraged loans, and asset-backed securities, including select mortgage-backed, and dividend-paying stocks. Real assets such as gold, infrastructure, and real estate present an attractive opportunity as a portfolio ballast for income generation and as an inflation hedge.

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.