The 1% Move Report

Wealth Management — June 13, 2022

• The S&P 500 declined 3.9% Monday to close at 3,750. With the sell-off, the index is now down 21.3% year to date.
• Markets continued to digest recent economic reports showing higher than expected inflation and lower than anticipated confidence as investors contemplated the potential risks to growth and margins. Only five of the S&P 500 constituents ended the day higher. The trading day sell-off extended the S&P 500 losing streak to four days and led the index to close in bear market territory (down more than 20% from the 52-week high). US 10-year Treasury yields rose to levels last seen in March 2011, while 2-year yields gained nearly 30 basis points in the biggest one-day increase since 2009. Additionally, the US Fed Funds futures market priced additional Fed rate hikes for 2022 as investors await Wednesday afternoon's FOMC rate decision. 
• All 11 S&P 500 sectors were lower, as Consumer Staples (-2.2%) and Financials (-2.9%) outperformed the broad market while Real Estate (-4.8%) and Energy (-5.1%) lagged.
• As of the 4pm equity market close, the 10-year Treasury yield rose to 3.37%, while 2-year Treasury yields moved 27 basis points higher to levels last seen in 2007 as the yield curve flattened. WTI oil declined to just above $120 per barrel, while gold was down 2.6% to $1,823 per ounce. The US Dollar Index strengthened in the session for the fourth day in a row.

• Economic Data: US CPI rose more than anticipated on Friday, up 8.6% YoY and 1.0% MoM. The underlying inflation pressures were broad based in the report, with both goods and services inflation accelerating. This included upside in car and apparel prices, as well as travel-oriented areas. Shelter prices also continued their ascent, with rent inflation rising to the highest level since 1987. In other economic data reported Friday, consumer sentiment fell sharply, with the University of Michigan Consumer Sentiment index declining to a record low.   
• Monetary Policy: Following last Friday's higher than expected CPI release, this Wednesday's FOMC press conference will provide an update on whether the previous guidance of "ongoing 50-basis-point increases in the target rate at the next couple of meetings" will still be feasible despite Fed Chair Powell's comment, at that time, that a hike of "75 basis-points is not something the committee is actively considering." Quantitative Tightening ("QT") began June 1. The reductions to the $9 trillion Federal Reserve balance sheet will occur within cap limits as $47.5 billion of securities will be removed each month for the next three months ($30 billion from Treasury securities and $17.5 billion from mortgage-backed securities). In September, the reductions will ramp to a maximum of $95 billion per month ($60 billion from Treasury securities and $35 billion from mortgage-backed securities). Currently, futures markets are pricing in 11, 25-basis-point hikes in the forward curve for the U.S., up from 8.3 hikes on June 9.
• Calendar: NFIB Small Business Optimism, US PPI (6/14); FOMC Meeting, US Retail Sales, US Business Inventories, Empire State Manufacturing Survey, NAHB Housing Market Index (6/15); Housing Starts, Jobless Claims (6/16); US Industrial Production, US Capacity Utilization (6/17).

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.

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.