Market Update

Portfolio Strategy

Weekly Market Guide

Michael Gibbs, Director of Equity Portfolio & Technical Strategy (901) 579-4346 | Joey Madere, CFA (901) 529-5331
Richard Sewell, CFA (901) 524-4194 | Mitch Clayton, CMT, Senior Technical Analyst (901) 579-4812

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Equity markets have sustained their advance with areas most levered to the economic recovery showing the strongest momentum. The small caps have now advanced 27% since the end of October and are now outperforming the S&P 500 year-to-date. At the sector and stock level, the hardest hit areas from the pandemic have generally seen the greatest upside. For example, Energy and Financials (down 52% and 22% respectively from 12/31 through October) have led the charge higher by 37% and 20% respectively since then. Also, S&P 500 stocks down 30% through October are up 36% on average since, a stark contrast to those up 30% prior to November being up (only) 11.6%. This phenomenon, spurred by very positive vaccine data and optimism over the recovery in 2021, is also being seen globally with a similar relationship between worst performers prior to the vaccine news correlating with best performance since then (led by some of the hardest hit Latin America and European countries).

The improved breadth is positive for equity market momentum over the intermediate term in our view. It has also created a good environment for active management with better opportunities for stock selection across all areas of the market. We recommend pro-cyclical exposure to portfolios, and believe it is important for investors to find a balance between the areas operating best through the pandemic along with the areas most levered to the economic recovery. Accordingly, our overweight-rated sectors are Technology, Health Care, Communication Services, Consumer Discretionary, and Industrials.

We remain positive on equities over the next 6-12 months due to our view of 3+ vaccines allowing an economic reopening as 2021 progresses, along with fiscal and monetary stimulus supporting the recovery and the likelihood of interest rates remaining lower for longer. This should support an earnings recovery and allow valuation to remain elevated (albeit lower than current levels). We maintain a base case S&P 500 target of 4025 (using $175 earnings and 23x P/E). And while the current equity momentum could continue through year end and into January, we do want to acknowledge numerous items that could impact volatility. Fiscal talks are currently ongoing (and we believe something likely gets done), but the absence of additional fiscal aid (with the virus surge and localized shutdowns impacting the economy) would be a setback. Additionally, the January 5th Georgia Senate runoffs have the potential to alter the legislative agenda dramatically in the event of a Democratic sweep. Therefore, our overriding view remains positive on equities. But we believe it is prudent to accumulate over time and make portfolio adjustments in a pragmatic way, particularly with new money coming in at current levels.

Also Highlighted in This Week's Report:

  • Seasonality
  • S&P 500 Trend Coming Out of Recessions
  • Distance from 200 Day Moving Average
  • Underlying Rotation since October
  • Consumer Discretionary
  • Industrials
  • Energy
  • December 17, 2020


    Eyes on the Horizon

    Brian S. Wesbury, Chief Economist
    Robert Stein, Deputy Chief Economist

    Nobody expected to see a rate change from this week's FOMC meetings, but interest remained high as the market awaited the latest Fed forecasts on where they see the US economy headed from here. And the updates to the Fed outlook were notable. GDP and inflation projections were revised higher, while the unemployment rate forecasts moved lower, all signaling a stronger economic recovery than the Fed believed possible earlier this year.

    How far have their forecasts come? Back in June, the Fed forecast the US economy would see a decline of 6.5% in real GDP in 2020, now they are targeting a decline of 2.4%. The year-end unemployment rate was projected at 9.3% back in June, but is now seen at (the current level of) 6.7% And future year outlooks have improved of late as well, both for economic growth and unemployment, which is now forecast to fall to 5.0% in 2021 and move below 4.0% in 2023. You may be tempted to think that the improved outlook may change the Fed's path for interest rates into the future, but that is the one area in today's report that remained unchanged.

    The Federal Reserve has no plans to move rates in 2021, 2022, or 2023 (which is as far out as they forecast in their projection materials). Only one of seventeen voting members believes any change in rates would be appropriate in 2022, while five believe that rates could move higher in 2023. During Chair Powell's press conference, the question arose about supply chain disruptions and the upward pressure those may put on inflation as the economy gets back to normal over the next twelve months, and while Powell acknowledged that may indeed lead to a pickup in prices, the question for the Fed is if those rising prices will be persistent. The Fed is basically saying, "We won't believe it until we've seen it...for a while." In other words, the Fed believes inflation will be transitory and won't force its hand on a rate hike for at least the next few years.

    Within the Fed Statement itself, the main notable change to the December release came from a clarification that the Fed plans to continue purchasing at least $80 billion per month of treasury securities and $40 billion per month of mortgage backed securities until "substantial further progress has been made toward the Committee's maximum employment and price stability goals." Again, the press conference brought additional light on this topic. The Fed believes (and we agree), that we still have a ways to go before the labor market has healed to where it was before COVID-19 reared its ugly head. Where we differ is in our belief that inflation will rise – and stay – above the Fed's target sooner and longer than it currently expects. That, in turn, would lead the Fed to raise rates before their post-2023 estimation. In the meantime, artificially low interest rates are a boon for stocks, which we believe remain undervalued, and poised for continued growth in the years ahead.

    This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

    December 16th, 2020


    Portfolio Strategy

    Weekly Market Guide

    Michael Gibbs, Director of Equity Portfolio & Technical Strategy (901) 579-4346 | Joey Madere, CFA (901) 529-5331
    Richard Sewell, CFA (901) 524-4194 | Mitch Clayton, CMT, Senior Technical Analyst (901) 579-4812

    View Full Report

    Please note, there will be no Weekly Market Guide next Thursday and publication will resume the following week on December 3rd. We wish you and your families a happy and safe Thanksgiving!

    Short-Term Summary: Since the end of October, there have been numerous data points bolstering our bullish bias to equities over the next 6-12 months, starting with success on the vaccine front. There are now two vaccine candidates with reported ~95% efficacy rates that will be asking the FDA for emergency use authorization in the coming weeks (positive news flow from other companies is likely too). Estimates suggest that ~30M Americans could be vaccinated by the end of 2020 and nearly 1/3 of the US population by the end of Q1. This is a big deal, as vaccinations in the most needed areas (i.e. those most vulnerable, health care, essential workers) should allow economies to reopen as 2021 progresses. Additionally, the likelihood of divided government drastically reduces the potential for tax increases acting as a headwind to the outlook (Georgia runoff for 2 Senate seats on January 5th still). Economic data and corporate earnings reports have continued to improve above expectations. And the Fed remains on hand to support the economic recovery as needed. All of this provides a sense of optimism for the year ahead, and our favored S&P 500 target for 2021 is currently 3910.

    However in the short term, the virus spread is surging. 10% of all tests nationally are coming back positive right now. Hospitalizations are at pandemic highs and continue to climb, putting pressure on local communities to implement targeted shutdowns. Additionally, there remains no progress on additional fiscal stimulus and questions remain over its potential timing and size. Sentiment polls and positioning have become more bullish, and many stocks are at overbought levels for the short term. For example, the average S&P 500 stock is up 12% and Russell 2000 is up 15% since the end of October. At the sector level, vaccine optimism has spurred large gains in the most economically sensitive areas- i.e. Energy is up 22%, Industrials up 14.8%, and Financials up 14.5% in just 13 days. This increases the odds of a normal pause or pullback as the market digests this strength.

    So while we are positive over the next 6-12 months, we would not be surprised for the road to be bumpy in the coming weeks and months. For this reason, we would use pullbacks as buying opportunities and would be pragmatic in repositioning portfolios toward the areas with more leverage to the economic recovery- i.e. small caps, industrials, materials, financials, and select consumer areas. We recommend accumulating these groups, for investors that have been underweight, as they go through consolidation periods. And would also maintain healthy portfolio exposure to the areas operating best through the pandemic- i.e. technology, health care, communication services, and areas within consumer discretionary. Opportunities at the individual stock level have improved across all areas of the market- a positive for active management as well as overall market trends.


    Portfolio Strategy

    Weekly Market Guide

    Michael Gibbs, Director of Equity Portfolio & Technical Strategy (901) 579-4346 | Joey Madere, CFA (901) 529-5331
    Richard Sewell, CFA (901) 524-4194 | Mitch Clayton, CMT, Senior Technical Analyst (901) 579-4812

    View Full Report

    Short-Term Summary:

    Following a three-week rally of 9% that put the index within just 1.5% of previous highs, the S&P 500 has consolidated slightly in recent days. We view the price action of the S&P 500 since the early September highs as a normal digestion of previous strength and are encouraged by investor conviction to continue buying the pullbacks. The potential for choppiness in the short term is there- overbought conditions, impasse on stimulus talks, and the upcoming election to name a few. However, we remain positive on equities over the intermediate term due to expectations of positive vaccine/therapeutic news flow, unprecedented stimulus, and record low interest rates fueling the economic and fundamental recovery over the next 12 months.

    Additionally, overall technical trends remain very positive. We note that the percentage of S&P 500 stocks above their 10 day moving average reached 94% in the recent rally. This is not a common occurrence over the past 20 years; and when it has occurred, average returns and win rates (probability of being positive) over the next 1, 3, 6, and 12 months have been significantly better than normal. For example, when the reading has reached >90%, the S&P 500 has averaged a 13.7% return over the next 12 months (with a 94% win rate)- comparing favorably to the 5.6% average return and 75% win rate in all periods.

    Earnings season began this week and so far results have been much better than estimates. Only 17 S&P 500 companies have reported thus far (majority of them Financials) but the average surprise has been 19%. This has put upward pressure on S&P 500 earnings estimates for the full quarter which have been revised up 2.1% already. This is a strong start as the 5-year average earnings surprise has been 5.6% for the full quarter, and particularly when factoring in the positive estimate revisions heading into results. On average over the past 15 years, estimates for the quarter have been reduced -5% only for earnings to "beat" these downwardly revised estimates, whereas estimates this quarter actually trended 5% higher. Despite this, the average price reaction for stocks on their earnings so far has been just -1.9%, but we believe this is more a function of the market's recent strength into results. Overall, we expect favorable earnings trends to continue.

    We continue to favor large cap growth. The small caps are improving but relative strength trends keep us from becoming too aggressive yet. We still like the Technology, Communication Services, Health Care, and Consumer Discretionary sectors, along with adding exposure to Industrials and Materials. Also, the emerging markets are giving a price breakout; and we would continue to accumulate on positive intermediate term trends supported by our expectations for a lower US dollar and global economic recovery in the year ahead.

    October 15, 2020