Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Inflation rose to multi-decade highs in December (7% y/y) and its impact on Fed policy remains top-of-mind for investors. The current trend makes an initial hike in March highly likely (93% market-implied odds and rising); and the question moving forward is if inflation will prove sticky at high levels (resulting in much tighter Fed policy) or if it will peak in the coming months. As discussed in our recent report Inflation and What It Means for Equities, our base case expectation is for inflation to moderate as the year progresses. We expect thawing bottlenecks to lead to inventory replenishment, which should ease inflationary pressures. Additionally, we are hopeful that Covid concerns can subside, allowing reluctant workers to return to the workforce and ease wage pressure. For these reasons, as the year develops, we expect investor perception to remain positive on the belief that the Fed will successfully navigate through current inflation concerns.
Nonetheless, uncertainty regarding this outcome will lead to weak periods for equities, such as that seen to begin 2022. And as the Fed embarks on the process of reducing its no-longer-needed stimulative measures, it seems logical that the equity market may find it more difficult to glide higher as it did in 2021. Historically, returns in the lead up to the first rate hike are solid with more moderate, but positive returns afterward. But we think this time could be different, as Fed policy has become much more telegraphed over time. This leads us to believe that normal volatility and choppiness may occur more in the lead-up to the initial rate hike (discussed in further detail here- Implications of Fed Policy Normalization on Equities). Nonetheless, we remain constructive on equities and would use pullbacks and rotation as opportunity. Our base case 2022 price objective for the S&P 500 remains 5053 (+8.5% from current levels before dividends).
Q4 earnings season begins tomorrow with several large banks and will likely be the dominant influence for several weeks. Over the next week, results will be Financials-heavy but with also initial indications from areas such as trucking, managed care, real estate, rails, media, and energy. The impact from Omicron’s surge over the past month, along with company outlooks on inflation and margins will be key to monitor. We expect a positive earnings season overall as demand remains elevated and margins continue to hold up well at high levels. The number of surprises and magnitude of beats are likely to be above historical averages, but the trend is also likely to continue moderating. In fact, 80% of the “early Q4 reporters” are beating earnings estimates by 7.5% (vs 71% and 5.3% longer-term averages).
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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
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