The 1% Move Report

Wealth Management — February 10, 2022

• The S&P 500 declined 1.8% Thursday to close at 4,504.  The index is now down 5.5% year-to-date, a 6.5% dip from its 52-week high. 
• Despite strong earnings releases from several companies after the close Wednesday, markets declined Thursday. The U.S. CPI data report Thursday morning showed inflation was higher than consensus forecasts: headline CPI rose 7.5% year over year, its highest level since 1982. And, shortly thereafter, the President of the Federal Reserve Bank of St. Louis, James Bullard, noted that he supports rate increases to as much as one percentage point by the summer of 2022. Treasury yields across the curve surged as a result of the higher than expected CPI print with the 10-year Treasury yield passing 2% for the first time since 2019. And, 2-year yields rose over 20 basis points to 1.61% in what was the largest daily move since 2009. 
• All 11 S&P 500 sectors were lower Thursday with cyclical equities outperforming the broad market. Materials (-0.6%) and Energy (-0.7%) were the relative leaders, while Utilities (-2.6%), Information Technology (-2.8%) and Real Estate (-2.9%) lagged. 
• The Nasdaq 100 fell 2.3% and the Russell 2000 Index dipped 1.6%. WTI oil closed near $90 and gold was modestly lower to $1,830 per ounce.

• 4Q21 Earnings: So far 69% of the S&P 500 has reported earnings results with 31% blended 4Q21 earnings growth year over year (y/y). Looking out to the end of 2022, current consensus estimated earnings growth of 7.5% y/y has fallen from the January 1, 2022 estimate of 8.4% y/y growth. Additionally, earnings revision breadth (the difference between sell-side earnings estimates that are upwardly revised and downwardly revised over the total number of revisions) is trending down in Communication Services, Consumer Discretionary, Financials, and Materials. We expect to hear from an additional 17 companies by the end of the day Friday, and 62 more next week. 
• CPI: The U.S. Consumer Price Index report showed inflation grew 7.5% year-over-year, up from 7.0% last month (+6.0% excluding food and energy), to levels last seen in 1982. The category with the greatest increase during January was used cars and trucks (+40.5% year-over-year), showing similar rates of growth to what was experienced last summer. The price index for new vehicles rose 12.2% and commodities (excluding food and energy commodities) increased 11.7% year-over-year, the strongest gain in price for the category since 1975. While US inflation continues to remain elevated, many other central banks around the globe are also dealing with increased pricing pressures as they also look to tighten monetary policy in the coming months. 
• Rates and Monetary Policy: The CPI release caused interest rates across the US yield curve to surge, with 2-year yields notably rising 25 basis points in what was the biggest daily move since 2009. Markets continue to gauge the timing and scale of future U.S. rate hikes that are anticipated to begin following the next Fed meeting March 15-16, and with today's CPI print the market is now pricing in more than 6 hikes for 2022. Regarding fixed income commentary, Morgan Stanley Wealth Management Chief Investment Officer Lisa Shalett recently 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 Morgan Stanley Financial Advisor for "The Fed Has Spoken. Now What?"
• Economic Calendar: University of Michigan Consumer Sentiment (2/11); PPI, Empire State Survey (2/15); Industrial Production, Retail Sales, business Inventories, NAHB Housing Market Index (2/16). 

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 likely 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 17US dollar against a subset of the broad index currencies that circulate widely outside the US.