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January 22, 2021

Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.

Short-Term Summary

Q4 earnings season is off to a solid start fundamentally. 87% of S&P 500 companies are beating their earnings estimates by an aggregate surprise of 20.4% so far, in line with the historically strong Q2 and Q3 surprises. And only less than a week in to the reporting period, S&P 500 earnings estimates for the full quarter have already been revised 2.5% higher. However, the very early read on price reactions has been lackluster, as the average price change on results is -1.5%. For example, Financials stocks have beaten estimates by 27.8% in aggregate but seen an average price reaction of -2.4%. Interestingly, the only two sectors with positive price reactions on average are Technology and Communication Services. It is far too early to determine if this will be the pattern for the full quarter, but the extreme run-up in the more cyclical areas over recent months has likely set the bar a little high.

Accordingly, over the past couple of days, we have seen some rotation back into the more technology-oriented areas. The Nasdaq Composite was able to break to new highs yesterday and is positive again today, whereas the Russell 2000 has moved slightly lower. This is also seen in Growth stocks regaining some ground, while Value cools off. Two days do not make a trend, but it would not surprise us to see some consolidation in the “recovery” areas. The small cap index is up 33% since the early November vaccine news, and S&P 500 sectors such as Energy and Financials are up 51% and 24% respectively since then. Also, the need for consolidation in some of the cyclical areas may only show up beneath the surface rather than a broad-market drawdown. As pullbacks occur in favored stocks, we would use them as buying opportunities.

The strong start fundamentally to earnings season bodes well for continued positive earnings trends in 2021. Positive 2021 revision trends on already strong earnings growth assumptions are important, as earnings will be the necessary driver of market returns this year with valuation expansion likely over. We remain of the view that vaccines will enable an economic reopening as 2021 transpires, with the recovery supported by both fiscal and monetary stimulus. President Biden laid out his coronavirus relief package which includes $1.9T in additional fiscal stimulus. Reports indicate he would like to pass this with bipartisan support, which could result in the final number being watered down and time until passage taking longer. Nonetheless, we believe something eventually gets done. This supports our above consensus (base case) view to 2021 earnings of $175. As earnings recover, valuation should begin to normalize. We use a 23x P/E multiple in our base case S&P 500 assumption for 2021 (down from the current 28x P/E multiple), as the low interest rate and inflation environment remains supportive of still elevated valuations in our view.

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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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