Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The S&P 500 has bounced ~6% from its recent lows and is still ~19% off its highs. Underpinning the slight rally has been broad weakness in commodity prices and lower bond yields. The lower inflation expectations are progress, and we note the June ISM manufacturing reading this week as further reflecting thawing inflationary pressures. However, clear and convincing evidence that inflation is moderating to more comfortable levels is likely to take time. Additionally, lower commodity prices are coming in part due to rising concerns of economic weakness.
Lower bond yields recently have been a boost to the Growth segments. Technology-oriented stocks, in particular, have been weighed on this year with the sharp ascent in bond yields- resulting in downward pressure on valuation multiples. Consequently, the group has seen some relative strength lately as bond yields stalled. Next Wednesday’s CPI report will be a key influence on the next wave of market trends. If inflation comes in hot, we may see an unwind of Growth’s recent pickup vs Value, along with lower equities broadly. On the flip side, a lighter report (in conjunction with improvement in underlying inflationary indicators) may ease pressure on Fed expectations in the back half of this year.
Also coming up next week is the start of Q2 earnings season. We believe the slowing economic backdrop and high inflation are likely to weigh on results and guidance. Forward earnings estimates are too high and likely set for downward revisions ahead in our view. That said, a lot of negative news has been priced in with the S&P 500 -24% off its highs (and P/E multiple down to 17x from 28x). And importantly, the market will bottom before the economy and earnings. For example, in the last two recessions (2009 and 2020), equities were well off their lows by the time earnings bottomed due to multiple expansion (stocks discount the future). We are not yet ready to say P/E multiples have bottomed; but when they do, forward returns are likely to be positive despite lower earnings to come.
Technically, the predominant market trend remains downward, and this will be the case until the series of lower lows and lower highs breaks. Our bias continues to be that equities likely have more challenges and additional weakness before all is said and done, but a lot of negative news has been priced in already. Long-term investors should refrain from getting overly negative with the S&P 500 already down over 20% from its highs, and should turn their focus to bull market potential rather than what may be left on the downside of this bear market. Recessionary bear markets average -33% historically, but bull markets gain 152% on average. Don’t lose sight of the opportunity on the other side of the current weak trend.
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