Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Volatility re-entered the market in recent days, as the S&P 500 has now given back 7% of its 44% gain from the March 23rd lows. Strength from the Technology stocks masked some internal deterioration earlier this week, as the Nasdaq composite was able to break out to new all-time highs while the average S&P 500 stock traded lower. A much-needed consolidation in the market then spiraled into the largest 1-day loss since March today (-5.9%), as investor complacency had gotten elevated. We remind you that pullbacks are normal (and to be expected), especially following the extremely rare up-move experienced over the past 50+ days.
We view this as a necessary pullback for the market to digest its gains, as the fundamentals can begin to catch up to price. Last week, we highlighted the 2009, 1982, and 1975 periods as the only other three instances with 25+% up-moves in a 50-day period since the 1930s. All of which were experienced coming out of recessionary bear markets, and were followed by a 1-2 month stall with a 6-7% pullback within. We would not be surprised to see a similar trend occur now as the rally “cools off.” Investor positioning has become complacent, and there are several items on the short term agenda that can spark volatility- for example, the spread of the virus with the economy re-opening, battle on next fiscal stimulus bill, and preparation for Q2 earnings season. The market remains overbought, and initial levels of support are seen in the 2895-3013 area (would be 7-10% pullback from Monday’s recent high). More pressing headlines (to alter the narrative) are likely needed in order to push the S&P 500 considerably lower than this range.
As this pullback plays out, we would use it opportunistically to accumulate favored sectors and stocks. We remain positive on the longer term opportunity, and continue to view the positives (i.e. enormous fiscal and monetary response) as outweighing the potential negatives (i.e. election, US/China trade rhetoric, virus resurgence). Also on a technical basis, extreme rallies to overbought conditions (as experienced since the March lows) are often indicative of above average returns over the next 12 months. Upside to our year-end base case S&P 500 price target (3111) will be much more attractive following a pullback. For example, if the S&P 500 were to trade to 2895, upside to this target would be 7.5% before dividends. Beneath the surface, the more cyclical areas (i.e. small caps, financials, industrials, consumer discretionary) are likely to be more volatile due to their more volatile earnings streams in the current environment, whereas the large technology-oriented and health care companies should be more stable. Tactically, we remain overweight technology, health care, and communication services; but believe this pullback will also create a good buying opportunity in those more cyclical areas for the longer term recovery.
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