Aoifinn Devitt – Chief Investment Officer
As we await the start of the third quarter earnings season, it is clear that there is likely to be considerable dispersion among sectors. Energy stocks are expected to dominate in terms of earnings growth, while other sectors, such as communications, tech, financials, and utilities are expected to see declines. Some companies are beginning to feel the effects of a strong dollar, which is impacting the price competitiveness of exports, while the relentless strength of the currency is also eroding the economic health of trading partners.
As markets continued to digest the recent US jobs report, which showed a rise in non-farm payrolls of 263,000 in September, the initial positive start to the month in equity markets was eroded. As we write now, markets remain on edge, and are inclined to react to the downside as rhetoric darkens. Examples of this include the recent suggestion by Jamie Dimon, CEO of JP Morgan, that the US was facing a “very, very serious” mix of headwinds, including the worsening geopolitical situation in Ukraine.
The Federal Reserve has telegraphed that it is likely to be highly data dependent as it decides on the future course of policy, and clearly two of the main data points it is focused on are inflation and employment levels.[1] It seems to be assured that some of its tightening to date (rate rises of 300 percent over 7 months) is seeing an effect on prices – in particular, the way that mortgage rates essentially doubling year on year have resulted in a sharp tick down in house price appreciation, so that average prices are likely to finish the year flat.
Other sectors, though, are experiencing more of a “lag in transmission” of tighter conditions and have not yet seen price reductions. It is notable that one of the areas that the Fed foresees as key to price reductions is margin compression in sectors such as retail – where margin expansion has latterly led to a windfall of sorts (e.g. in the used car retail segment). The margin expansion that was enabled when supply chain shortages met buoyant demand, far exceed the contribution of wage rises to the end price. Pressure on margins will likely translate into pressure on earnings for equities, and this is no doubt behind the weakness in current trading.
As we look around the globe, we can see mini financial experiments playing out on smaller stages – all of which are interesting petri dishes for policies not yet tried in the US, but potentially a harbinger of things to come. A prime example of this is the UK, where the governor of the Central Bank threw down the gauntlet to pension funds battered by falling government bond prices – telling them that they had “three days left” to reduce their exposures, at which point the bank backstop would be removed. Markets predictably reacted poorly. For now, it is critical to watch and learn from these developments, to avoid both further mistakes and deeper woes and also to take the temperature of market participants.
[1] See: https://www.federalreserve.gov/newsevents/speech/brainard20221010a.htm
Disclosures:
© 2022 Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment advisor does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified. Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.
Definitions:
The Russell 1000® Index is an index of 1000 issues representative of the U.S. large capitalization securities market.
The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 1000® Value Index measures the performance of those Russell 1000 Index securities with lower price-to-book ratios and lower forecasted growth values, representative of U.S. Securities exhibiting value characteristics.
The Russell Midcap® Index measures the performance of the mid-cap segment of the US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership.
The Russell Midcap® Value Index measures the performance of the midcap value segment of the US equity universe. It includes those Russell Midcap Index companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (2 year) growth and lower sales per share historical growth (5 years).
The Russell Midcap® Growth Index measures the performance of the midcap growth segment of the US equity universe. It includes those Russell Midcap Index companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 years).
The Russell 2000® Index is an index of 2000 issues representative of the U.S. small capitalization securities market.
The Russell 2000® Growth Index measures the performance of the small cap growth segment of the US equity universe. It includes those Russell 2000 companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 years).
The Russell 2000® Value Index measures the performance of the small cap value segment of the US equity universe. It includes those Russell 2000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (2 year) growth and lower sales per share historical growth (5 years).
The MSCI EAFE Index is a free float-adjusted market capitalization index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.
The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 21 emerging economies.
The Bloomberg U.S. Aggregate Bond Index is an index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities and mortgage-backed securities.
The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on the indices’ EM country definition, are excluded.
The Dow Jones U.S. Select REIT Index tracks the performance of publicly traded REITs and REIT-like securities and is designed to serve as a proxy for direct real estate investment, in part by excluding companies whose performance may be driven by factors other than the value of real estate. The index is a subset of the Dow Jones U.S. Select Real Estate Securities Index (RESI), which represents equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded in the U.S.
The Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX).
The S&P Global Infrastructure Index is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability.
