Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Since President Trump announced tariffs on China on August 1, the S&P 500 has been stuck in a range between the 50 DMA (2945) and 2822 (horizontal support and just above the 200 DMA). The S&P 500 is breaking out of this range today - there was a positive development from Hong Kong yesterday and an announcement that the U.S. and China will meet in D.C. for talks in October. With the upside break, our recent bias to the downside (which was predicated on an inability to break above resistance, some escalation of trade, and weak seasonality) is probably put to the side for now. However, we do not think the move today justifies unbridled enthusiasm since we still believe real trade improvement will be tough to come by, especially in the short term.
Nevertheless, trade and the Fed are the major short term influences right now, and the incremental positive is supportive. Technically, it will be important for the S&P 500 index to hold above the 50 DMA and not quickly roll over in the next few days. There is nearby upside resistance (2995-3027) that likely limits the magnitude of an up move unless something dramatic occurs with trade or the Fed. For tactical investors/traders, we think you can still be patient to see how the market reacts here and see if it is able to hold above the 50 DMA.
For long-term investors, we have a positive outlook and believe you can accumulate weak periods, as the value proposition to our 3108 base case next twelve month S&P 500 price target improves. Our outlook hinges on a solid consumer backdrop, along with a supportive Fed, and "Trump put." The strong 56.4 August ISM services report received today continues to reflect a strong consumer. This is important, as services make up ~89% of GDP vs manufacturing at ~11% (which is weak currently). For the Fed, we believe it will support the economic outlook (as it has stated) and are in easing mode. This is a reason we do not believe a stock market plunge like last Fall is in the cards (a time period where the Fed was hiking rates and interest rates were moving higher in the midst of trade tensions). For the "Trump put," while his behavior has been erratic on trade, we have seen him soften his stance when the economy and market come under pressure. In the end, we believe he will push trade to the back burner as election season heats up. Since World War II, there have only been two incumbents that lost re-election (Carter 1980 and Bush Sr. 1992). Both times the economy was in contraction, unemployment was rising, and real disposable income growth was below 1% y/y. President Trump knows he needs a good economy and stock market over the next year.
Fundamentally, sales growth has been strong (strong consumer), but margin estimates have been trending lower since last September (when President Trump initiated the tariff increases on China), which is weighing on earnings growth. Our 2020 S&P 500 earnings estimate is $176. The 15% tariffs that just went into effect could hit that number by ~$1. For now, we hold it to see if the tariffs stay in place and how the tariffs impact economic data. Valuation is interesting given the equity risk premium is 1.5 standard deviations above its historical average. Trade is the major headwind though. We think the current P/E of 17.7x moves to 18.5x in our base case outlook (below the historical 19.1x median P/E when inflation is 2-2.5%). In general, we continue to favor U.S. Large Cap growth, particularly companies with higher exposure to the United States.
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