Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The S&P 500 rally paused over the past week, after recovering roughly half of its -34% plunge from 2/19 to 3/23. With the index just under its 50 day moving average (following a 27% move off the lows) and a band of technical resistance from 2901-3136, we would not be surprised to see equities pull back in the short term. We also believe that market bottoms are a process, as it would be very unusual for the S&P 500 to simply V-bottom back to previous highs. It is more normal in recessionary bear markets to have a “grind it out phase” where the market can rebuild itself internally for a more durable path higher. Thus, we would reserve some buying power to accumulate pullbacks. Initial downside technical support is 2644 with more support at 2538 and 2455.
Q1 earnings season is moving along with 23% of S&P 500 companies having reported thus far. The market response to results has been generally positive, ex-Financials. The banks have had to take on large loan loss provisions which has added to their earnings impact in the current environment. Some of the best earnings reactions have come from Technology-oriented stocks, as supportive results were needed following very stable estimate revisions heading into earnings season (along with strong relative performance this year). Overall, the S&P 500 is now expected to see a -14.4% earnings contraction in Q1, with the majority of weakness from the Energy, Consumer Discretionary, Financials, Industrials, and Materials sectors. These stocks have, accordingly, felt the brunt of the weakness in this bear market. Whereas, sectors with the most stable estimate revisions- i.e. Health Care, Technology, and Consumer Staples- have seen some of the best performance.
For the full year 2020, S&P 500 earnings estimates continue to cascade lower, toward our estimate of $130. We continue to believe the trajectory of the recovery will be more important for the equity market, where we expect directional improvement in the back half of this year and into 2021. However, the deteriorating earnings picture, accompanied by the sharp market rally, has brought the S&P 500 P/E on a next 12 month basis (NTM) up to 19.1x. This is above the P/E (NTM) at the market peak on 2/19. While it is normal to see higher multiples on lower earnings, the lofty valuation in conjunction with all of the uncertainty and challenges remaining (in regard to testing, therapeutics, virus spread, restarting the economy, etc.) contributes to our recommendation of patience in the short term. In fact, the S&P 500 currently trades in line with our base case 2020 S&P 500 target of 2797. The current virus situation is fluid, and details can quickly shift toward our upside case (3128) or downside case (1914). However, with the risk/reward balanced fundamentally in our view for the short term, we would look to be more aggressive on a market pullback.
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