The 1% Move Report

Wealth Management — September 26, 2022

• The S&P 500 Index declined 1.0% Monday to 3,655, below the June 16, 2022 closing low of 3,667. With the sell-off, the index is now down 23.3% year to date. 
• Stocks extended their slide on Monday as Treasury yields continued to show strong upward momentum. While price/earnings ratios have corrected some with the spike in rates, we believe equity valuations could go lower. Fixed income markets are reacting to a backdrop of hawkish global central banks amid elevated inflation pressures. At present, the US 2-year Treasury yield rose above 4.3% today for the first time since August 2007, and is now up 93 basis points the past month. 
• Elsewhere, the British Pound traded within 1% of all-time lows relative to the US Dollar as policy makers pushed back on an emergency rate hike to help stymie the currency's sharp decline. Additionally, the US Dollar Index, which measures the currency's value against a basket of global currencies, is now at levels not seen since 2002.
• As the end of the third quarter nears, we believe U.S. equity markets will continue to weigh the effect of elevated inflation, higher rates, and slowing growth on corporate earnings and valuations.  
• Ten of the 11 S&P 500 sectors declined, with Consumer Staples (0.0%) and Consumer Discretionary (-0.2%) the relative outperformers, while Energy (-2.6%) and Real Estate (-2.6%) underperformed.
• WTI oil fell to $77 per barrel while gold declined to $1,624 per ounce. The 10-year Treasury yield rose 21 basis points to 3.90%, now at the highest level since 2010.

• Monetary Policy: Last week Fed Chair Powell announced a 75-basis-point hike following the FOMC's rate meetings and reiterated that the committee "will keep at it until ... confident the job is done." The committee's "Summary of Economic Projections" showed that members anticipate that monetary policy will continue to be restrictive for some time as expectations for the fed funds rate remain well above the 2.0% target rate at least until 2025 and the timing of future rate cuts is not apparent. The committee's median fed funds rate projections are for 4.4% in 2022, 4.6% in 2023, 3.9% in 2024, and 2.9% in 2025. This suggests that there is the potential for additional hikes in November, December, and into 2023, at least until it is clear that inflationary pressures have eased. Currently, fixed income markets are pricing in an 80% chance of a 75-basis-point hike at the November meeting and an 90% chance of a 50-basis-point hike following the meeting in December. MS & Co.'s Ellen Zentner expects a 75-basis-point hike in November, 50-basis-point in December, and 25-basis point in January to a terminal rate of 4.625% in January. Zentner expects rates to remain at this level until December 2023 when a first rate cut of 25-basis-point may occur. Regarding the balance sheet reduction program, Fed Chairman Powell previously indicated that the run-off of the mortgage backed securities (MBS) portion would occur once the run-off is well underway. While the balance sheet reduction program doubled earlier this month, during this week's meeting, Fed Chair Powell indicated that MBS sales are not expected any time soon. 
• Calendar: Durable Goods, New Home Sales, FHFA House Price Index, Conference Board Consumer Confidence (9/27); Pending Home Sales (9/28); GDP revision (9/29); Personal Income & Spending, Chicago PMI, University of Michigan Consumer Sentiment (9/30). 

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 2024E 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 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.

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.