The 1% Move Report

Wealth Management — July 26, 2022

• The S&P 500 Index decreased 1.2% to 3,921 on Tuesday as 65% of S&P 500 constituents were down on the day. With the decline, the index has fallen 17.7% year to date. 
• Second quarter earnings are in full swing this week as more than half of the S&P 500 constituents will have reported by Friday. Thus far, a number of management teams lowered guidance due to inflationary and margin pressures, while others noted that the second quarter benefitted from improved pricing. Investors also await key economic data this week, such as US GDP and US Core PCE, as well as Wednesday's FOMC rate decision where MS & Co. economists anticipate a second consecutive 75 basis point hike.
• While Utilities (+0.6%) and Health Care (+0.6%) outperformed the broad market, eight of the 11 S&P 500 sectors closed lower Tuesday. Communication Services (-2.1%) and Consumer Discretionary (-3.3%) were the largest underperformers. Declines in these sectors were broad based with 95% of the Consumer Discretionary constituents and 73% of the Communication Services constituents down on the day.
• As of the 4pm equity market close, the 10-year Treasury yield rose to 2.81% and 2-year yields increased to 3.05%. WTI oil declined to $95 per barrel, while the US Dollar Index modestly improved.

• Q2 Earnings: Thus far, nearly 29% of the S&P 500's market cap (132 companies) has reported results, with 72% beating earnings forecasts. An additional 124 companies are expected to report by the end of the week. Energy company earnings are driving much of the growth, with expectations for S&P 500 2Q22 blended earnings growth to be 6.2% (-3.2% excluding Energy). During company 2Q22 earnings calls, investors will be closely monitoring forward guidance as well as vulnerability of margins and earnings due to headwinds from slowing growth, higher input costs and deteriorating demand conditions.
• Monetary Policy: In view of continued inflationary pressures (June's headline CPI came in ahead of expectations at 9.1% year over year), markets anticipate that the Federal Open Markets Committee (FOMC) will announce a second 75 basis point hike following the July 26th-July 27th FOMC sessions. MS & Co. economists concur with a 75 basis point raise tomorrow and forecast 50 basis points in September (75 basis points if inflation accelerates further). The balance sheet run-off will continue to ramp through September. MS& Co. economists expect this program to run through 2Q24.
• Economic Calendar: FOMC Rate Decision, Durable Goods, Wholesale Inventories (7/27); US GDP, US PCE (7/28).

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 continued caution in the indices remains intact. Our June 2023 base case provides a target of 3,900 for the S&P 500. This scenario assumes earnings and revenue growth decelerates due to high cost pressures in a slowing growth environment. Our June 2023 bear case of 3,350 considers a slowdown in earnings growth rate, margin pressure, sticky inflation, and a recession. Our June 2023 bull case of 4,450 corresponds to a soft landing environment where earnings growth slows but remains positive, inflation decelerates, cost pressures ease, and confidence improves. This bull case forecast embeds an estimate of 17.9x forward June 2024 earnings. With earnings revisions moving lower off the prior peak, investors should focus on risk management through quality factor exposure, defensiveness with regard to interest rate sensitivity, and attention to stock-specific valuations. We are moving to a position of maximum diversification by sector and market cap, with interesting ideas in Energy, Industrials, Materials, Health Care, Consumer Services, Financials, Utilities and Staples. 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 for core investment grade, 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.

Consumer Price Index: Examines the weighted average of prices of a basket of consumer goods and services.

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.

University of Michigan Consumer Confidence Index: Measures three broad areas of consumer sentiment: personal finances, business conditions, and buying conditions.

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.