Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Short-Term Summary
Sector rotation played out this week, as many of the lagging areas- financials, industrials, consumer discretionary, and small caps- outperformed substantially. For example, these groups were up 8.6% on average this week, as the former leaders- technology, health care, communication services- “cooled off,” up just 0.7% on average. We would like to see follow through from the small caps and deep cyclical areas, as for now it was just an overdue “catch up” trade. Nevertheless, this was some much-needed improvement in market breadth, and it resulted in the S&P 500 continuing its grind higher.
The S&P 500 is now up a remarkable 36% in 46 days, and back above its 200 DMA for the first time since March 5th. It is fairly normal historically for equity markets to enter a more volatile sideways trend, following the initial recovery back to the 200 DMA, with multiple 3-7% pullbacks occurring over a period of time. We also continue to believe the S&P 500 is likely to trade within a range of 3130 to 2630 for weeks to months. With the S&P 500 getting closer to the upper end of that range, we would be relatively patient and selective with purchases in the short term. As sector rotation plays out, we expect opportunities to present themselves at the individual sector and stock level. For example, we view health care’s fundamental outlook attractive and, after consolidating some of its strength over the past several weeks, would look to accumulate here.
Fundamentally, forward earnings estimates for the S&P 500 have stabilized in the past two weeks and begun to move slightly higher. The forward P/E has also continued to move slightly higher to 21.6x. It is our view that the primary driver of market returns will need to shift from valuation expansion to earnings growth, as further valuation expansion will likely be harder to come by (unless an effective therapeutic or vaccine is announced). As investors change focus toward earnings, this can reintroduce some volatility. Additionally with so much uncertainty surrounding the trajectory of the economic and earnings recovery, as well as the virus spread, China rhetoric ramping back up, and the election upcoming, we believe volatility is bound to happen at some point. Thus, we would reserve some buying power to take advantage of those pullback opportunities for the long term. Remember, bear markets are often very fast and violent, whereas bull markets last for years. The S&P 500 is 36% off the lows in 46 days, but bull markets have lasted 1,233 days on average and seen price gains of 155%. So while the market has reached overbought conditions in the short term in our view, the long term opportunity remains.
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Index Definitions
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market.
The MSCI World All Cap Index captures large, mid, small and micro-cap representation across 23 Developed Markets (DM) countries. With 11,732 constituents, the index is comprehensive, covering approximately 99% of the free float-adjusted market capitalization in each country.
MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations.
MSCI Emerging Markets Index is designed to measure equity market performance in 23 emerging market countries. The index’s three largest industries are materials, energy, and banks.
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