Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The technical backdrop remains heavy with equities staging an unimpressive rally from oversold levels over the past week, and the S&P 500 experiencing its sharpest 1-day decline in almost two years yesterday. Short-term momentum indicators continue to point lower, and positioning has yet to reach capitulation levels. Investor sentiment, i.e. the AAII bull-bear survey (contrarian indicator), is bearish enough to form a bottom but the equity put/call ratio has yet to spike to levels often consistent with durable lows historically. Additionally, the 5-year high yield CDS (credit default swaps) index has been one of the best indicators for short-term trends this year and continues to push to new highs- indicating the S&P 500 is likely to push to new lows.
The #1 market influence right now is high inflation and uncertainty over its path moving forward. Investors have been continually disappointed by inflation over the past 6+ months, as the Omicron variant, Russia/Ukraine war, and China lockdowns have consecutively disrupted its potential trajectory. The longer inflation stays high, the more pressure it puts on the Fed to hike rates aggressively- potentially to the point of economic contraction (in order to bring inflation down). We believe inflation has peaked, but the degree of inflation improvement will ultimately be a large determinant of market trends.
Last week’s 0.6% m/m reading was disappointing, as it will take m/m readings in the 0.2-0.3% m/m range over the rest of the year to bring core CPI to a ~4% level that the Fed can become more comfortable with. We believe this is possible; but the market has gotten to the point where it needs to see inflation coming down in order for Fed expectations to ease.
While market momentum remains lower, valuation has become more compelling. There are many companies with earnings significantly above pre-pandemic levels while prices are now near or below 2019 levels. Earnings typically win out in the long- term, so when the dust settles, this pullback will present attractive opportunity in our view. In assessing potential downside, we believe there is fundamental and technical justification for the 3400-3600 range. At 16x trailing earnings, which corresponds with the P/E seen in the 2015-2016 manufacturing recession, late 2018 trade war selloff, and 2020 Covid shutdown, the S&P 500 could trade to 3424 (-11% lower than current levels) in a downside scenario. But the degree of the recent selloff can produce sharp bounces at any point and we believe equities will be higher over the next 12 months. With this in mind, we recommend long-term investors use the downdrafts as opportunities to selectively accumulate favored stocks- while increasing conviction once the technical backdrop becomes more supportive. For more on what we’re looking for at a bottom, please see our recent note HERE.
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