Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
At 2500, the S&P 500 is up 12% from its closing lows on 3/23 (still 26% off its highs on 2/19). We view the recent bounce as part of the bottoming process, and believe there is still plenty of work to do before stocks can begin an enduring move higher. The key remains the spread of the virus, and we continue to believe things will get worse before they get better. Unfortunately, several weeks of very bad data are coming. Mid-April is when the White House thinks the number of new cases could peak (also NYC hydroxychloroquine results come around the same time- could prove positive). When the number of new cases plateau, we believe markets will begin trading a little better. The economic impact will continue to be cumbersome, but a slowing in the spread will provide more support to equities. In response to the global economy screeching to a halt, the Fed and White House are producing record stimulus to combat the deterioration, with monetary and fiscal stimulus estimated around 20% of US GDP (with the potential to increase toward 30%). The record stimulus has also come in record time- largely being anticipatory, rather than reactionary. So in the steps to stabilization, the Fed’s signal of unlimited willingness to support liquidity and White House’s stimulus package to limit economic damage are supportive. The final step is to stop/slow the virus outbreak, and this keeps us guarded on equity markets in the short term.
We believe the equity market is moving into a third wave currently. The first wave was the 23 day -34% “waterfall” selloff when uncertainty and fear of the situation was compounded by forced liquidations and credit concerns. The second wave was a 6-day 18% bounce as liquidity was restored and fiscal measures pass. We believe the next wave will be a pause or pullback as focus on the virus and potential length of the economic shutdown are contemplated. Outcomes (and forecasts) are all over the board, which is normal in a period of uncertainty due to a major catalyst. As a result, earnings estimates are impossible to have certainty. We would start turning focus toward 2021 estimates, and the question will be the trajectory of corporate fundamentals following their current weakness (i.e V-shaped, U-shaped, square root-shaped, etc.). Also, valuation will not provide support in the short term but will once again matter once the dust settles. The S&P 500 currently trades at a 15x P/E, below the long term average of 16.5x. Relative to bonds, the equity risk premium (earnings yield – bond yield) is up to 5.6%- at the high end of its historical range. Once equities find a bottom, low valuation will boost long term returns as earnings eventually normalize. Bottom line- We believe the current bear market will prove to be a tremendous opportunity for long term investors, but would accumulate in partial positions (reserving buying power as more clarity is gained on the duration and impact of the virus spread).
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