Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Lower inflation expectations and bond yields are underpinning an impressive 13% S&P 500 rally from oversold levels over the last 32 days. Equities have nearly retraced half of this year’s losses since mid-June, and the current relief rally has been the longest and largest seen this year. Importantly, there have been positives in the bounce that lower the odds of prolonged or meaningfully more downside.
The most significant development has been broad weakness across the commodity complex. This should filter through to lower inflation ahead, and is already showing up in some economic data- i.e. ISM Services prices paid (a leading indicator on inflation) dropped considerably in July. Also, the national average price per gallon for unleaded gasoline has contracted to $4.16 (from a peak of $5) and mortgage rates have declined since mid-June, all of which should ease the strain on US consumers. Lower inflation expectations have influenced lower bond yields, which are moderating their sharp ascent seen over the first half of this year. This, in turn, is supporting equity market valuations, which are now at more reasonable levels (from very elevated levels last year).
Although the current market rally off the bottom is impressive, we don't expect stocks to run unbridled to new all-time highs in the coming months as they did following the 2018 trade war plunge and 2020 Covid shutdown. Stocks often take time to rebuild after trying and uncertain periods. Inflation remains very high and will not allow the Fed to come to the rescue as it did in late 2018 and 2020, which influenced a V-bottom in stocks for both periods. Additionally, the lag effect of current Fed tightening will weigh on the economy and earnings growth in the months ahead- as market concerns shift from inflation toward economic and fundamental weakness. For these reasons, a more prolonged period of back-and-forth trading is most likely in our view.
While recent price action suggests the S&P 500 is attempting to transition to more of a sideways trend, the predominant trend remains downward for now. Moreover, the S&P 500 is now overbought in the short-term and approaching resistance in the ~4200 area. Tactically, this provides some pause to chase the rally, along with overall leadership still skewing defensive- supporting our expectation for setbacks in the weeks to months ahead. We recommend using those pullback periods as opportunity to accumulate favored stocks and reposition portfolios. While there is likely more time or weakness to go in this bear market, don’t lose sight of the bull market opportunity on the other side of the current weak trend.
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