Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The S&P 500 has now pulled back ~9% over the past two weeks, fueled last Friday by the market’s reaction to Fed Chair Powell’s hawkish tone at Jackson Hole. The Chairman’s message echoed recent comments from other FOMC members with an intent to firmly state that inflation is too high, the Fed is determined to bring it under control, and it will likely take a prolonged period of higher rates (and slower economic growth) to achieve this goal. The result is “higher for longer” rate expectations in the aftermath, pushing the 2-year yield to new highs (~3.5%) and the 10-year yield moving higher as well- reinvigorating weakness in equities.
The market’s move since mid-June (a 17% two-month rally, followed by the current 9% pullback) has provided a lot for the bulls and bears. Bears believe the market’s gains were nothing more than a bear market rally, failing at obvious 200-day moving average resistance, and that a much lower low will occur. Conversely, the bulls believe that the lows are in and that the current pullback is normal. Our view is we do not expect a 2001 (dotcom bubble) or 2008 (credit crisis) type market where significant bear market rallies preceded much lower prices. Supply has been hard-pressed to match demand in this cycle, there is a lack of widespread excess, the banks are very well-capitalized, and technology companies are real (far from the speculation of the dotcom era). Additionally, commodity prices have broadly pulled in since mid-June and inflation has likely peaked. Therefore we still favor odds that the lows are in. However, even if not, we doubt that stocks will decline significantly below the lows barring a catalyst that alters the path of inflation and interest rates. We do believe the bear market (at least, in terms of time) will continue. Economic normalization after the pandemic (and the resulting impact on inflation) will take time to play-out. Therefore, volatile/ confusing data remains likely. Plus, the lag effect of tightening on the economy will cause a moderation in earnings for a while. Retests and choppiness are a high probability, such as being experienced now.
In the short-term, equities are broadly oversold enough for a bounce; and we would like to see technical support around 3900 hold. This area represents horizontal support (resistance in June & July, and support in late July), the uptrend line that connects the June low to the July low, and the 61.8% Fibonacci retracement from the June low to August high. Failing to hold this area likely sees a retest closer to the lows (3720-3636). Overall, we continue to view this as a rebuilding phase/bottoming process, but Fed actions and market reactions will be highly dependent on the path of inflation ahead. Today’s ISM Manufacturing showed a continued decline in prices paid, which bodes well for inflation trends. Up next, investors will be watching the August jobs report tomorrow (including wage growth), followed by August ISM Services on Tuesday, and August CPI on 9/13.
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