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March 19, 2021

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

Covid trends continue to move in the right direction with hospitalizations down over 70% from the peak in early January, new daily hospitalizations down 90%, and new cases down 78%. Vaccinations are also ramping up with 65% of all 65+ year old Americans and 28% of all 18+ year-olds having received at least one dose. This is allowing states to relax stay-at-home measures. And as the economy appears set for a reopening, the Treasury is sending out stimulus payments from the $1.9T bill passed by Congress recently. Meanwhile, the Fed kept rates unchanged at its FOMC meeting this week, not wavering from its dovish stance and the majority of Fed officials expecting to maintain a 0-0.25% fed funds rate through 2023. All of this contributes to our positive view on the economic recovery set to transpire this year. In fact, the Fed increased its GDP growth estimate for 2021 to 6.5% (from 4.2%) and for 2022 to 3.3% (up from 3.2%).

The improving macro backdrop- vaccinations indicating a reopening of the economy as 2021 transpires, boosted by unprecedented levels of fiscal and monetary stimulus- continues to result in an upward trend to analyst earnings estimates. We have an above consensus $190 S&P 500 earnings estimate for 2021 which reflects 37% earnings growth y/y. The best earnings growth is expected from the hardest-hit areas in 2020, and the best estimate revision trends continue to come from Energy, Materials, Financials, Tech, and Comm. Services.

As earnings recover, valuation should normalize from elevated levels. The surge higher in interest rates is resulting in a quicker re-rating for some of the higher relative valuation areas (i.e. tech-oriented), however credit spreads remain low- indicating a lack of pressure on corporations from higher rates beneath the surface. We continue to believe that rates are rising for the right reasons- better economic growth expectations- rather than tighter monetary conditions. In fact, the Fed reiterated its dovish stance yesterday and committed to maintain asset purchases of $120B/month. For these reasons, we believe that valuation normalization will not outweigh rapid earnings growth in the year ahead. We use a 22x base case P/E assumption (from 27.2x now) to achieve our 4180 S&P 500 price target.

Technically, the S&P 500 was able to rebound from its ~4.5% pullback to reach new highs this week. As has been the case in recent months, the advance was broad and driven by the most cyclical areas. The strong market breadth (in tandem with the rise in rates) not only supports intermediate term technical momentum, but also our view that rates are rising for the right reasons. In the short term, the market may need to consolidate its 5.5% two-week advance, but we continue to recommend using weakness in favored sectors and stocks as buying opportunities.

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