Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The S&P 500 index has advanced to new highs to begin Q3, but the story continues to be rotation beneath the surface. For example, Large Cap Growth is up 7.8% over the past month, while Large Cap Value is down -1.8% (and Small Cap Value is down -7.4%). This resurgence of Growth (and narrowing breadth) has come in conjunction with continued downside in the US 10-year Treasury yield recently (now down to 1.29%), along with the corresponding narrowing yield curve. There are many variables contributing to this moderation in rates, including rising concerns over the Delta variant, very low global yields, along with the Fed purchasing a large portion of Treasuries. But technically, we have also thought it natural for the US 10-year Treasury yield to digest its historically sharp rise from November to March, in which it stretched 94% above its 200-day moving average (largest spread on record). We have been keying on technical support near its 200 DMA (1.20-1.30%) for some time now, so with the US 10- year Treasury yield now approaching these levels, we wait to see how it responds to support. It remains difficult to determine how long the moderation in interest rates will play out. But ultimately, we still stand in the camp that interest rates are likely to grind higher over the next 6-12 months due to strong economic growth, increasing inflation, and the Fed coming off of its ultra-accommodative stance.
Interest rate movements will continue to have a large influence on sector rotation in our view, but low interest rates in general are supportive of overall market trends. We also are not overly concerned with the narrowing yield curve as credit spreads remain very narrow (positive indication on underlying corporate stability), along with continued weak relative strength trends from the more defensive sectors (i.e. Utilities and Consumer Staples). Pullbacks are bound to happen, and a moderation in the pace of market ascent is expected over the next 6-12 months. However, we continue to view the positives (strong fundamental and technical backdrop) as outweighing the potential negatives. As such, we recommend using short-term pullbacks as long-term buying opportunities.
Q2 earnings season is set to begin next Tuesday; and while S&P 500 earnings estimates have been trending higher, they still appear too low in our view. We expect a large percentage of companies to beat estimates by an above average rate- continuing the trend of historically strong surprises over the past several quarters. In fact, the "early Q2 reporters" have beaten estimates by 17% so far. Inflation will be a key talking point on earnings calls, as investors focus on margin impacts. We will also be watching the market's response to results, as price reactions have been below average for the past several quarters despite strong results (particularly for Technology).
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