Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
September’s equity market pullback continued this week, extending the drawdown to -10% in 15 days. The “no news” consolidation turned into a selloff more concerned with the macro environment. A rise in COVID cases, primarily in Europe, along with an impasse on additional fiscal aid from Congress is creating less of a cushion for the economic recovery process.
With an understanding that the market may struggle over the next month (pre-election, macro uncertainty), we would accumulate the weakness. We continue to view the pullback as a normal correction as opposed to a shift to a bear market. The most likely downside in our view is 3100-3200 on the S&P 500 (1-3% more downside), which would put the S&P 500 near its 200 day moving average (DMA) at 3106 currently. The percentage of stocks above their 10 and 20 DMA is at short term oversold levels, and the percentage of stocks above their 50 DMA is also very near levels that often coincide with short term lows in normal corrections. Additionally, the pullback has shaken out the complacency that had set in to investor positioning. We have not yet seen a spike in the put/call ratio to “capitulation” levels, but we do believe the table is being set for the next rally.
The pullback has also made the fundamental risk/reward more attractive to our S&P 500 fair value target. Our base case target for the S&P 500 by year-end 2021 remains 3600 which is now 13% upside from 3200. We remain positive on the economic recovery process over the next twelve months, and believe valuation can remain elevated due to global stimulus and record low interest rates. As such, we see S&P 500 earnings climbing back near 2019 levels at $160 through 2021 and apply a P/E of 22.5x (vs the S&P 500’s current 23x P/E).
In terms of what to buy during the market pullback, we would generally stick with the “winners”- favored names in the Technology, Communication Services, Health Care, and Consumer Discretionary sectors (particularly near technical support levels). We would keep a foundation of these areas, while also beginning to accumulate “recovery” areas- Industrials, Materials, and select Consumer Discretionary stocks. It is also still too soon to increase allocations to the small caps. We would remain patient there and continue to overweight Large Caps. We also recommend sticking with Growth over Value, with continued weakness from the Financials our main reason. Globally, the US remains our favored area, but we would use the weakness in Emerging Markets (coming in conjunction with a short term bounce in the US dollar) as a buying opportunity for the longer term.
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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
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