November 20, 2020
Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Equity market momentum remains solid- grinding slightly higher over the past week to begin December and following a historically strong November. The S&P 500 is 13% higher since October 30th, while the average stock and small caps are up 19.5% and 24% respectively. This enormous strength and improved market breadth are technically positive for forward returns over the longer term. For example, returns over the next 3, 6, and 12 months have historically been above average following 10+% returns in one month. However, returns over the following month are typically below average.
Technically, the base breakout to new highs remains the dominant force, and the three-month base could make the current wave last longer and gain to a greater degree. But we would not be surprised to see consolidations or pullbacks occur at some point in the short term. We note that the S&P 500 is still flirting with overhead trend line resistance at ~3700, along with elevated investor optimism and very low put/call ratios. These are not great timing indicators, but do suggest the need to refrain from unbridled enthusiasm. If the market moves lower, watch horizontal support at 3550, and then the 50DMA (currently at 3507). A 3-5% pullback to these levels would be very normal and healthy for equities in our view. We would use pullback periods as a buying opportunity for the year ahead.
Our base case assumption of 3+ vaccines with strong efficacy rates should allow an economic reopening as 2021 progresses, a tailwind to the global economic recovery. We also believe additional fiscal aid will ultimately get done (potentially some by the end of December). The likelihood of a divided Congress (Georgia Senate runoffs on Jan. 5th are a key variable to monitor) also would remove longer run concerns over aggressive legislative changes to the tax code. We believe that S&P 500 earnings can reach $175 in 2021 and that valuations can remain elevated (albeit move lower from current levels) due to the likelihood of low interest rates and inflation. Our 23x P/E assumption results in a base case S&P 500 target of 4025 (~9.5% upside from current levels before dividends).
In sum: We remain positive on equities over the next 6-12 months, and recommend a pro-cyclical exposure to portfolios. Strong technical momentum has many areas overbought in the short term. As consolidations or pullbacks occur within favored sectors and stocks, we would accumulate for the longer term recovery ahead.
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