Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Equities were able to shake-off coronavirus concerns over the past week, rallying back to highs on the S&P 500. Contributing to the move was the People's Bank of China injecting 1.2T yuan into their markets to support the economy through the virus impact. Additionally, positive economic readings this week, i.e. US ISM manufacturing moving back into expansion, global manufacturing PMI advancing, and US ISM services surprising to the upside, supported the view that economic conditions were improving in January (before the coronavirus impact).
It remains our view that global central bank stimulus and trade progress should be tailwinds to global economic activity throughout 2020. We acknowledge the unfortunate impact of the coronavirus, and its effects can be a headwind to economic conditions until concerns subside (particularly in China). However, we believe the market impact is likely to be more transitory and do not see it altering the intermediate term thesis at this point. The US remains our favored place to invest globally. Also, it is interesting that China was able to hold support at its 200 DMA and bounce this week. We came into the year thinking China and EM could outperform the World in 2020, but we do think it is too early to make meaningful commitments to these areas with uncertainty so high over coronavirus ramifications.
We nudged up our base case S&P 500 P/E to 19.5x (from 19.25x) due to trade progress since the start of the year, and our next 12 month earnings estimate moved to $175 in order to incorporate January into our forecast. Coronavirus impacts have not altered these forecasts, as we typically take a more conservative stance to forward estimates. For example, we use 1.8% US GDP this year in our earnings estimate, while a 2.0-2.3% GDP could result in S&P 500 earnings closer to $177-180. This would be our bull case scenario (S&P 500 at 3717 using $177 earnings and 21x P/E) of continued trade progress, better than expected economic activity, and a Fed on hold. So while our bias is higher, the risk/reward to our base case target (3413) improves meaningfully during normal pullbacks. As such, we would use pullbacks as buying opportunities.
Beneath the surface, there was some rotation into Value this week (Growth has dominated YTD performance thus far) as interest rates bounced and the yield curve steepened in conjunction with the positive move in manufacturing ISM. An improving manufacturing trend is influential on many of our 2020 investment themes. With bond yields bouncing off the low end of its range, we believe banks can catch up in the short term. Also, industrials are one of our favored areas to accumulate as manufacturing improvement takes shape.
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