Key changes from May report:
- § Upgraded view of energy to positive from neutral
- Downgraded view of communications services from neutral to negative
Stocks staged a furious late-month rally to break even in May, but the S&P 500 Index ended the month down more than 12% year to date. The index fell more than 20% from its January 3 high on an intraday basis on May 20 but avoided closing 20% below the all-time high, keeping the bull market alive.
Market participants remained on edge due to high inflation and the risk that the Federal Reserve over tightens monetary policy to combat it, sending the economy into recession. The lack of a cease-fire in Ukraine, ongoing COVID-19 lockdowns in China, and weakness in retail earnings further pressured investor sentiment.
The intense pressure on bonds over the first four months of the year eased up some in May, as the 10-year U.S. Treasury yield pulled back from near 3% to 2.83%.
The Strategic and Tactical Asset Allocation Committee (STAAC) made only minor asset allocation changes for June, including shifting from communication services to energy, which translated into a modest value tilt. Our S&P 500 Index year-end fair value target range remains 4,800— 4,900, based on a price-to-earnings ratio (PE) of 20.5 and our 2023 earnings per share (EPS) estimate of $235.
- § We continue to recommend a slight overweight to equities versus bonds on the belief that recession fears may be overdone.
- We suggest a slight tilt toward the value style in the short term, though we would expect an improved macroeconomic environment to create a more favorable environment for the growth style later this year, including falling inflation and stable interest rates.
- § We would expect large caps to lead during this period of economic uncertainty, though attractive valuations and a U.S. focus may provide support for small caps in the near term.
- § We continue to recommend a slight underweight allocation to fixed income as higher rates may put additional pressure on bond returns.
- Although we’ve seen a meaningful move higher in yields this year, broadening inflationary pressures and the reduction of Federal Reserve (Fed) policy support may push yields still higher in the months ahead. Our year-end target for the 10-year Treasury yield is 2.25% to 2.5% but expect yields to stay elevated in the 2.75% – 3.0% range in the near term.
- § Shorter maturity corporate credit and high yield bonds (for income-oriented investors) are starting to look more attractive.
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