Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The S&P 500 has put up a 7-month streak of positive returns, along with not experiencing a 5% pullback (on a closing basis) since last Fall. We believe that strength begets strength, and strong returns through August bode well for positive performance through the remainder of the year. Historically (since 1950), when the S&P 500 is over 20% higher through August, the index has finished higher by year-end 86% of the time by an average 3.25%. This supports our view of positive returns in the outlook, but we also want to be mindful of the seasonally soft period of the year coming in September-October. With plenty on the agenda (i.e. taxes/ infrastructure, debt ceiling, geopolitical concerns, tapering, among others), it would not surprise us to also see volatility by year-end. We also continue to monitor soft participation beneath the surface of the market’s ascent. As the index has continued to gain since April, the percentage of stocks above their 50- and 200-day moving averages has retreated. Additionally, the NYSE advance/decline line has been unable to gain since June. We are not overly concerned by the softer breadth given the market’s proclivity for rotation in the current environment, along with still positive longer-term trends. However, this is a divergence to continue monitoring, as a narrow market can be a vulnerable market (to pullbacks). Pullbacks may continue to occur more at the sector and stock level, but we recommend some pragmatism with new purchases along with using weakness as opportunity.
Fundamentally, strong New Orders (66.7) in the August Manufacturing ISM report bodes well for continued upside in earnings estimate revisions; and we expect New Orders to stay high as inventories get replenished from very low levels. Supply chain shortages continue to result in inflationary pressures, however heightened demand- supported by enormous stimulus and very low interest rates- is continuing to offset these supply issues. The result is many companies having been able to meet or beat margin estimates, and trends remain positive. This demand supports a continuation of the strong fundamental recovery. And accompanied by very low interest rates and narrow credit spreads, valuation has been able to hold at high levels. Despite the S&P 500 being over 20% higher year-to-date and over 100% higher from the March 2020 lows, the value proposition (vs bonds) remains positive for equities due to very strong earnings and exceptionally low interest rates. The equity risk premium (difference in S&P 500 earnings yield and US 10 year Treasury yield) is 2.7%, which remains historically high (or attractive)- roughly 1-standard deviation above the 0.6% average since 1960. To be sure, we expect forward returns to moderate as the recovery progresses from here (with normal volatility and pullbacks along the way). However, we remain positive on the outlook and expect positive intermediate-term returns (still early in the bull market).
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