Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The path of least resistance remains higher for the S&P 500 as it continues to climb within its trend channel (in place since positive vaccine news last November). The tailwinds of stimulus, the economic recovery, strong fundamentals, and low interest rates (no alternative to equities) continue to leave the market in a bullish mode and prevail over the headwinds of inflation, macro disappointments (Covid, supply chain), elevated valuation, and potential tax changes. At some point, the narrative will shift and normal pullbacks will transpire- the S&P 500 has not experienced a 5% pullback since last October. However, we view weakness as likely to be normal in nature and should be used opportunistically when it occurs.
Despite the continued glide higher at the index level, participation beneath the surface continues to tell a slightly different story. Breadth continues to narrow in the market ascent, though intermediate term trends remain supportive. And we believe this could be where the opportunity lies. As Covid concerns and supply chain shortages have weighed on the macro environment and investor sentiment toward areas levered to the recovery since May, the “pandemic winners” have regained strength and largely driven performance (+13% on average). Conversely, the “recovery stocks” have generally underperformed since May (-8% on average), albeit still within solid absolute price trends closer to their 200-day moving averages. We view this digestion of prior strength as very normal and healthy technically. Covid cases (and hospitalizations) appear to be peaking and given our positive view on the economic recovery ahead, we see opportunity within these more recovery-oriented areas (i.e. Energy, Financials, Consumer Discretionary, and Industrials).
Fundamentally, earnings trends remain strong and supportive of equity prices. Consensus estimates for the final two quarters of 2021 and all of 2022 continue higher on solid margin trends. Supply chain issues remain, resulting in upward pressure on input costs, but demand remains high and continues to offset these pressures. The Delta variant has undoubtedly resulted in some slowing of economic momentum, but we view this as transitory and see the impact as moderate. Additionally, the demand/supply imbalance economically bodes well for continued fundamental strength, as inventories get replenished from very low levels over time. And accompanied by still very low interest rates, valuations have been able to hold at lofty levels. We expect valuation to normalize over time, but do not believe its pace will outweigh earnings growth- allowing for continued upside to equities in the outlook.
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