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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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


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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Short-Term Summary:

There is no shortage of market-influencing variables at the moment. The on-again, off-again news flow of stimulus talks continues. We remain skeptical of additional fiscal aid ahead of the election with policy differences the major obstacle to a deal. This provides less of a cushion for consumers in the short term, but we believe the overall recovery can continue (potentially at a slower pace) and still believe fiscal stimulus is likely to come after the election.

The Presidential election is also just one month away with the betting odds trending in favor of a Biden win and a potential Democratic sweep. Emotional responses to the election outcome can often create short term volatility at the sector level. However, we do not believe dramatic changes to portfolios should be made based on the election alone. Overall, we do not believe the election outcome will alter the over-riding theme of this environment over the intermediate term, which is an economic recovery supported by stimulus in the early stages of a bull market.

Elsewhere, there has been encouraging COVID-19 therapeutic data from Eli Lilly and Regeneron over the past week. Importantly, both treatments- using neutralizing antibodies- are for non-hospitalized patients. This is promising as previous therapeutics have been for patient use in the hospital and on oxygen support. Additionally, RJ Biotechnology analyst Steve Seedhouse believes we could have two vaccines- Pfizer/BioNTech and Moderna- with emergency use authorization by the end of November. We expect better news on a vaccine and therapeutics to continue, and this contributes to our positive stance on equities over the next 12 months.

If that wasn't enough, Q3 earnings season begins next week. Estimates have been trending higher into the results on better than expected economic data, now reflecting a -21% earnings contraction y/y (but +18% q/q sequential improvement). We do not expect earnings to beat as drastically in Q3 as they did in Q2 (a historic ~25% surprise to the upside), but we do expect an overall positive quarter with continued earnings improvement moving forward.

Through all of this, market behavior has been encouraging. The S&P 500 was able to push above horizontal resistance at 3429 today, which (if able to hold) puts the path of least resistance up to prior highs at 3580. Market internals are also firming up for the next move higher in our view. The S&P 500 advance/decline line broke out to new highs. We note good leadership from the semiconductors and transports- positive indications of economic and equity market momentum. Also, participation is broadening out with the small caps breaking to new recovery highs. The potential for choppiness is there, but all of this bodes well for equity market momentum over the intermediate term.

October 8, 2020


2020 3rd Quarter Equity Market Update

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

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Outlook:

Despite the market swoon seen in September, we remain constructive on the recovering economy even as the momentum in high frequency data has moderated some recently. Overall, the economy is much stronger than the March low and continues to make slight improvement, which keeps us constructive. While there are numerous risks such as resurgence of COVID-19 cases, uncertainty in the improvement of the economy, and the Presidential election, we continue to believe the positives outweigh the negatives with our base case S&P 500 price target of 3,600 at year end 2021. Earnings continue to improve, and we expect a nice earnings recovery from 2020 levels with our base case assumption of $160 in earnings power, just shy of the ~$161 reported in 2019 (consensus estimates imply growth from 2019 levels with EPS expectations of $164.75). As we get further clarity on these above risks, we could see further revisions to 2021 EPS estimates. Historically, as the economy emerges from recessions, analysts tend to be overly conservative with estimates and actual results coming in better-than-expected.

Despite our reluctance to rely on elevated multiples to justify our price target, we feel valuation can stay elevated vs. historical averages given the substantial policy stimulus, low inflation and low interest rates that likely remain below trend for some time, TINA (there is no alternative) market, better than feared progression on vaccines, and the tendency for valuations (P/Es) to stretch coming out of recessions. Currently, we acknowledge that P/E's are elevated compared to historical averages, but not anywhere close to the extreme levels seen during the dot com bubble period. Moreover, we believe, given the low inflation and low interest rate environment, we do not believe it is suitable only to rely purely on the absolute P/E level. Instead, we would use the inflation adjusted P/E and equity risk premium (ERP) as alternatives for valuation. As such, our 2021 fair value base case P/E assumption of 22.5x appears elevated on the surface, but when taking into account our expectation for 1.5%-2% inflation, the inflation-adjusted P/E of 24x-24.5x would by relatively in-line with a one standard deviation move above the average. Moreover, with the ERP currently at 3.5%, we find equities much more attractive than bonds and the S&P 500 has historically seen positive returns over the next 3-year (annualized) when the ERP is above 3%, which provides further support from a valuation perspective that upside in is warranted for equities.

From a sector standpoint, we have seen sector rotation during the September market swoon. During the pullback of 3.9% for the month of September, the leadership positions YTD were amongst the worst performing sectors, which those sectors that have underperformed YTD were amongst some of the best performers. We believe this broadening out of the overall market is necessary, but we would rather see a ‘rising tide lifting all boats’ market rather than one in which the leading sectors must fall in order for the lagging sectors to catch up. From a fundamental perspective, those cyclical sectors that were the hardest hit by the COVID-19 pandemic are expected to rebound the fastest YoY in 2021. Moreover, some of the least impacted areas such as Tech and Health Care are expected to see the best EPS growth from 2019 levels. Thus, we would maintain our bias towards cyclicals/growth sectors.

Finally, with the upcoming Presidential election, we believe the next month or so will be pivotal. While it is human nature to try to position portfolios for the eventual outcome of the election, this strategy has historically not be effective. A surprise on election night could offset any portfolio changes made in advance. Moreover, even once the results are known, we would caution against crowding into areas "thought" to benefit the most. Those sectors that responded the most immediately following President Trump's election victory, have been amongst the worst performers throughout the remainder of his presidency. Given that rising taxes are such a hot topic in this election, we believe the reality of tax hikes is likely to be less severe than the fear/risk of higher taxes as reforms to tax code are unlikely to take place until 2022 or beyond or until the economic environment is on more stable footing. As such, we would not make dramatic portfolio asset allocation changes as we move towards the election.

October 2, 2020


Dramatic Changes to Portfolio Allocations Should Not Be Made on the Election Alone

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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Summary:

The election is just two months away and attention to it is set to ramp up from here. From a seasonality perspective, it is historically common for the stock market to be soft in the September-October timeframe. This is particularly the case in contentious elections when the incumbent party has a higher likelihood of losing control. However while emotions may run high and impact market volatility, the overarching themes of the environment remain the most influential forces to returns over the intermediate to longer term. Our upward bias remains to equities with the positives of unprecedented stimulus fueling the economic recovery, record low interest rates, and low inflation outweighing the potential negatives of election uncertainty, tax changes, virus spread, and geopolitical tensions. For this reason, we would not look to make dramatic changes to portfolio allocations in the lead up to election day. We would maintain portfolio diversification, and use any potential weakness as a buying opportunity.

Current election betting odds indicate close to a “toss up” in terms of Presidential outcome and potential for a Democratic sweep. The gap has narrowed recently and these odds are set to fluctuate in the weeks ahead. Also, while current polling odds may indicate current opinions, plenty can change in the lead up to election day. And history suggests these polls need to be taken with a “grain of salt” in predicting future outcomes. Many investor concerns toward the presidential outcome circulate around the potential for higher taxes. Presidential candidate Joe Biden has stated his intent to raise the corporate tax rate to 28% from 21% currently (President Trump had lowered from 35% to 21%). In order for this to occur a decisive Democratic sweep would likely need to happen. And even so, the potential for higher taxes would likely not come before 2022 especially if the US economy is still in the midst of recovering from COVID-19. We estimate the S&P 500 earnings impact from this move to be ~10% with many of the more cyclical, hurt areas in the current environment feeling these effects more on a relative basis. We also believe the odds of a large fiscal stimulus package, along with lower tariffs, are increased in the event of a Democratic sweep which will offset the impact of higher taxes to a degree- and these are also likely to come prior to higher taxes.

Needless to say the uncertainty surrounding the election outcome and its effects to the equity market is high. We remind you that emotions can create volatility for areas of the market that may or may not ultimately meet those expectations. For example, following the 2016 election, technology and health care were two of the immediate underperformers, however they were two of the best areas throughout the presidential term. On the flip side, energy was expected to be a beneficiary of lower regulation and lower taxes; and though it did initially outperform through 2016 year end, it was down in 2017 despite higher oil prices (and is down -48% since 2016 election day). Additionally, financials were the biggest outperformer in the immediate aftermath, but did not provide outperformance from that point on through the presidential term- the sector actually trades in line with where it did in early 2017 currently.

For these reasons, we would not look to make dramatic changes to portfolio allocations based on the election alone and would refrain from emotional responses that alter your long term goals and objectives. Equity market volatility can occur (broadly and for specific subsectors), but this often ends up being an opportunity for the longer term.

September 2, 2020


Consensus forecasts come from Bloomberg. 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.