LIVE MARKETS Amid fog-of-war, Evercore ISI cuts S&P 500 year-end target
Summary Main U.S. indexes fall around 1.75%-2.25%; chips, banks hit harder
Cons disc weakest major S&P 500 sector; Utilities lead gainers
Dollar, gold, crude gain; bitcoin falls
U.S. 10-Year Treasury yield edges up to ~1.75%
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AMID FOG-OF-WAR, EVERCORE ISI CUTS S&P 500 YEAR-END TARGET (1348 EST/1848 GMT)
Evercore ISI is lowering their S&P 500 (.SPX) year-end 2022 target to 4,800 from 5,100. Of note, the reduced target is still more than 13% above current levels.
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Julian Emanuel, a senior managing director, leading the equity, derivatives and quantitative strategy team at Evercore ISI, says uncertainty is the major driver behind the change.
“The uncertainty – European bank weakness, newly parabolic (Wheat and Oil) commodities, nuclear threats – has yet to fully ‘wash ashore’ to the U.S.”
However, he says that signs are emerging, including incremental funding stress, “haven” dollar strength, and curve flattening reflecting oil’s potential to dampen growth.
Set against the backdrop of a hiking Fed, Emanuel believes this will continue to weigh on stocks consistent with Evercore’s blueprint for equity weakness into and after the March 16 FOMC Meeting. With this, he says that a test of 3,670, while not his base case, cannot be ruled out.
Emanuel addresses why he is retaining a full-year positive market view by says that “although the growth trajectory for the U.S. economy is moderating it remains strong, moving toward ‘reopening’. And the forward returns history of defensive investor sentiment is one of rising share prices.”
Until the “fog of war” abates somewhat, he is recommending investors maintain a balanced exposure, while focusing on value over growth, and “companies with pricing power and margin expansion capabilities, convex to inflation.”
“While cash depreciates in inflation, it lets the investor be in position to buy into further material weakness, not sell. Over 100 years of Bear and Bull markets, selling weakness has been a consistently unprofitable strategy even when times become more uncertain.”
UNDERVALUED SMALL CAPS COULD SHINE (1310 EST/1810 GMT)
After months of underperformance compared with large caps, U.S. small caps stand out as an undervalued segment of the market, Jonathan Golub, chief U.S. equity strategist & head of quantitative research at Credit Suisse Securities, wrote in a note Monday.
This underperformance in U.S. small-capitalization stocks has come despite much stronger earnings, and “has left smaller names extremely undervalued relative to their larger peers” he wrote.
However, given recent market turmoil amid Russia’s invasion of Ukraine that has driven up volatility, investors should take a note of small caps.
“Small caps tend to outperform when the VIX (volatility index) and ISM are elevated, as they are today,” he wrote, noting that small caps “tend to do better in periods of economic strength, a function of their superior operating leverage.”
The Russell 2000 small-cap index (.RUT) is down more than 12% year to date, while the S&P 500 (.SPX) is off more than 10%.
FLAT YIELD CURVE DOESN’T NECESSARY MEAN RECESSION RISK IS HIGH (1202 EST/1702 GMT)
The U.S. Treasury yield curve has reached its flattest levels in two years as spiraling oil and commodity prices increase growth concerns, but Morgan Stanley notes that the move does not necessarily indicate an elevated recession risk in the near term.
The two-year, 10-year yield curve reached 22 basis points on Monday, its flattest level since March 2020, and is down from 92 basis points at the beginning of the year. An inversion of this part of the yield curve is seen as a reliable indicator that a recession will follow in one-to-two years.
However, “higher commodity prices don’t always result in recession, at least in the US,” Morgan Stanley analysts including Matthew Hornbach said in a report, noting that commodity prices tend to rise a lot after recessions end, when demand for commodities increases and growth accelerates.
Rising energy prices may also not have the same impact on the economy as they have in the past, as the United States imports much less crude oil and petroleum products today, they said.
As for the yield curve, a major reason for its flatness is that the Federal Reserve owns almost 30% of outstanding nominal coupon debt, Morgan Stanley said.
While a recession typically occurs after the yield curve inverts, it also usually comes after Fed rate hikes, though neither is a perfect indicator of when an economic downturn is likely, Morgan Stanley said, noting that it is better to focus on how and whether exogenous shocks, such as the Russia-Ukraine conflict, could push the economy into recession.
Depending on Fed policy, shocks that eventually lead to a recession can steepen or flatten the yield curve, but in both cases they usually send yields lower, Morgan Stanley said.
The recent drop in Treasury yields “suggests the probability of recession has risen – but probably from an exceedingly low level, given the amount of monetary stimulus still in the economy,” the analysts said.
“As the Fed raises rates this year, the probability of recession will rise, all else equal. And, yes, the yield curve will flatten, in all likelihood. But we think the yield curve will flatten much more before a US recession arrives than in previous cycles, even if energy prices and geopolitics moderate,” the analysts said.
BUYBACK, DIVIDEND GROWTH IN 2022 COULD BE STRONGER THAN EXPECTED (1100 EST/1600 GMT)
Investors might expect corporate America to accelerate the pace of its share repurchases and dividend issuance this year, according to Goldman Sachs.
In its Weekly Kickstart note, the investment bank hikes its 2022 S&P 500 buyback estimate to $1 trillion, or 12% more than in 2021 (up from 8%).
A “strong backlog of authorizations, which YTD is running above last year’s record of $1.2 trillion,” is one reason for the increase, writes David Kostin, Goldman’s chief equities strategist.
Other reasons cited by the broker include solid sales and earnings growth, along with healthy cash balances.
The breadth of buyback activity so far this year “stands near a historic high, with the number of active programs double the typical amount,” the note says.
“Following the conclusion of 4Q earnings season, companies have exited their buyback blackout windows and appear eager to reenter the market after the sell-off in US equities,” Kostin adds, while identifying a recent regulatory proposal from the Securities and Exchange Commission as a potential risk to the bank’s forecast.
The brokerage firm also upped its dividend growth forecast to 10% from 8%, with energy stocks (.SPNY) expected to lead the charge, powered by higher oil prices , and solid cash flow growth.
Kostin also says high dividend stocks perform well in high-inflation environments.
“A sector-neutral strategy of owning the companies with dividend yields in the top quintile of their S&P 500 sectors has historically outperformed the index by 8 percentage points over a 12-month horizon when headline CPI registered above 6%,” he writes.
The charts below, courtesy of Goldman Sachs, show the investment bank’s S&P 500 dividends per share forecast, along with median 12-month return of high dividend stocks at times of cool versus hot inflation (click to enlarge):
Goldman Sachs dividend forecast
EUROPEAN ENERGY SECURITY IN 3 STEPS (1022 EST/1522 GMT)
The Russia-Ukraine war has exposed a weak spot for Europe’s economy – the reliance on energy imports – and with crude at 2008 levels and gas at record peaks investors are trying to position themselves for what governments will do to ensure better energy security for the region.
Natixis economist Patrick Artus, also formerly board member at France’s No.1 energy group TotalEnergies, has looked into the question and believes Europe will deal with its energy vulnerability issues in three ways.
In the short term, by increasing government support to low-income households to offset the rise in energy prices In the short to medium term, by diversifying natural gas suppliers (in favour of the United States, Qatar) In the longer term, by accelerating nuclear programmes in the countries that allow nuclear energy (France and Finland today; possibly other countries such as Italy in the future); certainly by accelerating renewable energy programmes and investment in Europe to produce the necessary equipment.
And if you missed it, here’s a 10-point plan by the International Energy Agency (IEA) for Europe to reduce its reliance on Russia.
U.S. STOCKS OPEN IN THE RED AS COMMODITY PRICES SURGE (1000 EST/1500 GMT)
U.S. stocks opened lower on Monday as oil and other commodity prices soared as the United States and European allies considered banning Russian oil imports, raising concerns about their impact on growth.
Oil prices rose to their highest levels since 2008 and are up more than 60% since the start of 2022. read more
The main U.S. indexes are now in the red, with the Dow Jones Industrial Average (.DJI) taking the biggest hit. The small-cap Russell 2000 (.RUT) is proving to be resilient, now trading around the flat line.
Of the 11 major S&P 500 (.SPX) sector indexes, eight are in the red. Financials (.SPSY), communication services (.SPLRCL) and information technology (.SPLRCT) are among the worst performers. Energy (.SPNY) is the best performer, with utilities (.SPLRCU) and industrials (.SPLRCI) also posting modest gains.
Here is your early market snapshot:
IS OIL THE ONE ABOUT TO BE SHOCKED? (0900 EST/1400 GMT)
As the Russia-Ukraine conflict has intensified, NYMEX crude futures are flirting with important technical resistance. Thus, oil may be on the verge of a surprise downside reversal. read more
Crude prices spiked to their highest levels since 2008 on Monday as the United States and European allies weighed a Russian oil import ban and delays in the potential return of Iranian crude to global markets fueled supply fears. read more
With this, U.S. stock futures were slammed with banks and travel stocks falling the most as rising oil prices added to concerns over spiraling inflation and slowing economic growth.
Amid Monday’s panic, NYMEX crude futures spiked to $130.50, but have since sold back sharply to the $118 area. As stands, this action puts the futures on track to form a bearish shooting-star candle, suggesting potential for an exhausted rise.
Meanwhile, at current levels, the futures are trading at 2.03 times their 200-week moving average. Of note, oil put in a major top in 1990, and again in 2008, when the 200-week disparity hit the 2.07/2.08 area:
Additionally, weekly momentum is severely overheated. The RSI, at just over 88.00, is at its fourth most overbought reading going back to mid-1983.
In any event, crude could still gyrate through the week, and the disparity could still finish Friday around the 2.07/2.08 area. However, in 1990 and 2008, it only took one to two more weeks, before crude then reversed violently to the downside.
Thus, it may shortly become clear whether the fire under crude will run much hotter, or instead, if its rise was indeed burning out.
Of note, as crude’s shooting-star candle is forming early Monday, U.S. stock futures are now well off their worst overnight levels. read more
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Terence Gabriel is a Reuters market analyst. The views expressed are his own
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