Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
US equities have continued slightly higher to begin the new year, as the positive trade tone and seasonality have supported sustained momentum. While the technical backdrop remains healthy, we believe the general market is stretched to the upside (10% above the 200-day moving average) and likely in need of consolidation. We would not be surprised to see a pause or light pullback and view initial support at 3212, followed by 3191 and the 50 DMA at 3150. A move to this level (~3.3% lower) should be viewed as healthy, and we would use it as a buying opportunity.
The rise in equity markets has taken the S&P 500 P/E up to 20.0x on a trailing 12-month basis and 18.3x on a forward basis. This is also getting stretched to the upside, as the 18.3x P/E is approaching the market’s peak multiple following tax reform (18.8x). In 2019, the bar was so low (NTM P/E of 14.3 at the start of the year) that trade progress and a dovish Fed acted as tailwinds to multiple and market expansion. There is a high bar now (NTM P/E of 18.3x), so we believe earnings growth will need to be the major contribution to market returns this year.
We do expect solid earnings growth in 2020 of 5.5% (using our S&P 500 earnings estimates of $174 and $165 in 2020 and 2019 respectively). Q4 2019 earnings season begins next Tuesday, so corporate results could reintroduce some volatility back into the markets (at least at the company level). The US and China are also expected to sign phase one of their trade agreement next Wednesday, January 15th. Q4 earnings estimates have remained very stable over the past two months, albeit still reflecting a -1.1% earnings contraction, if actual results follow a similar "beat pattern" as the first three quarters of 2019, final results are likely to finish closer to 2% growth. The average S&P 500 company is expecting Q4 earnings growth of 3.5% currently.
The spark in Iran tensions has been short-lived (so far), however it created some rotation beneath the surface due to a risk-off move in interest rates. As the US 10 year yield moved lower, Growth was able to advance meaningfully vs Value to begin the year. Now that tensions are subsiding, we are interested to see if a potential reversal back into Value plays out. The Financials have consolidated some of their relative strength, and we view the sector as attractive to accumulate at current levels. Additionally, oil prices are consolidating after spiking higher on the initial Iran news. The Energy sector is, in turn, consolidating its recent strength as well. We are, again, interested to see if the Energy sector can hold above support levels, which it was unable to do multiple times last year. It is our bias that Energy is trying to turn, but tactically we would wait and look to accumulate the sector as its upturn proves sustainable.
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