Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
We don’t enjoy the phrase “data-dependent” any more than you, but it is the environment we are in right now. Investors have been conditioned for years to take “bad news as good news” because inflation was low and the Fed could come to the rescue (with supportive stimulus). We do not have that luxury right now with inflation so high (and the jobs market still solid). Because of this, inflationary data will be highly influential on the Fed’s path ahead- and in turn, market movements. Good news last week- i.e. ISM prices paid showing lower price pressures and August wage growth moderating- contributed to equities bouncing out of a weak trend. Then, this week’s stickier-than-expected August CPI reading saw equities give back those gains.
The major issue continues to be high inflation increasingly weighing on consumer disposable income and, in turn, purchasing power. And the longer inflation stays high, the increased risk of it becoming entrenched. In response, the stickier inflation becomes, the more hawkish the Fed will need to be in order to bring it down to a more reasonable level. This increased Fed tightening and the inverted yield curve will negatively impact lending and economic growth ahead. Additionally, bond yields have risen on the higher Fed expectations this week, which weighs on equity market valuations. For example, stock valuation (relative to bonds) has not become more attractive on the pullback due to the higher bond yields.
The path of inflation ahead obviously remains paramount for equities. Overall, we expect inflation to moderate over the next year due to lower commodity prices, an improved supply/demand imbalance, and lower wage pressures. Because of this, we still favor the worst of this bear market likely being behind us. However, the path is unlikely to be quick or smooth. And it will be difficult for equities to show sustainable upside with inflation so high and the Fed in tightening mode. Technically, we are monitoring support at ~3900, but weakness (in the aftermath of Tuesday’s hot CPI report) raises the odds that this level does not hold. A move below 3900 will increase the odds of a retest or undercut of the lows at 3637 with potential support around 3800 and 3742 on the way.
The result is a bear market that likely takes time to digest the inflationary data flow with back-and-forth trading over the coming weeks and months. With this in mind, we recommend not chasing the rallies and using the pullback periods (which could be double digits) as opportunity to accumulate favored stocks for the next bull market.
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