March 26, 2021
Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Interest rate movements continue to have an outsized influence on sector rotation, remaining the dominant underlying theme driving day-to-day activity. Difficulties in Europe's vaccine rollout and virus spread are resulting in new stay-at-home restrictions in the region. And this (among other things) has contributed to a pause in the sharp rate of ascent for bond yields. Consequently, there has been some consolidation in the “reflation trade” of late. For example, Small Caps, Energy, and Financials have pulled in by 10%, 10%, and 4% respectively from their recent highs. These areas are reaching short term oversold levels near their 50 DMA within intermediate term uptrends, and we would use this as an opportunity to accumulate for those building positions in them.
The market has become more of a grind lately, and this may become more of the norm as we enter year two of the recovery. A year ago when the economy was shutting down from Covid and the S&P 500 had just experienced its worst 1-month decline (-33%) since the 1930s, the message was volatility is likely to remain high but forward returns over the next 12 months are typically well above average following historic drawdowns. Flash forward to now and the S&P 500 has just experienced its best 1-year return since the 1930s (+75%). Looking at other periods of exceptional 12-month returns historically, there are still high odds of gains in the next year; but the rate of return becomes more normal. And these periods (like most) do not move in straight lines, as drawdowns will occur along the way. This is not troubling, but expect weakness (may be seen more at sector level) and take advantage as it occurs.
Underlying technical momentum remains solid for equities for the intermediate term, as the economic and fundamental picture improves. Momentum is also building toward an infrastructure stimulus package (which may come in two phases), and taxation will become part of the discussion as a way to pay for it. We view the spending (in conjunction with already passed fiscal and monetary stimulus) as a net positive for equities, and believe the upward trend in earnings estimates continues. Our 2021 earnings estimate of $190 remains well above consensus estimates of $174. At the sector level, the deep cyclical areas are driving this upside, although technology continues its fundamental strength too. With valuation elevated, robust earnings growth will drive market performance this year in our view. And if our estimates prove true, the S&P 500 will reach pre-pandemic forward valuation multiples by year end- reflecting a more normalized economic and fundamental backdrop. Our base case S&P 500 target for 2021 is 4180, resulting in an increased value proposition for equities as weakness occurs.
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