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

The eagerly-anticipated September inflation report was a disappointment. Core CPI rose 0.6% m/m (above the 0.4% consensus estimate), taking the y/y reading up to a new high of 6.6%. Shelter rose another 0.7% m/m and food 0.8% m/m. The bottom line is this report will keep the Fed hawkish. A 75bp hike in November is all but certain, and increases the likelihood of an additional 75bp hike in December.

Inflation remains the primary influence on equity markets. The longer it remains sticky, the more pressure it puts on the U.S. consumer and Fed. We remain encouraged by the soft, survey-based economic data indicating that inflation should moderate over the next year. For example, this week’s NFIB Small Business survey showed a continued decline in both price plans and compensation plans (in the next 3 months). However, investors are still waiting on the leading indicators of inflation to show up in the hard, actual data. It will be difficult for equities to sustain upside without convincing improvement in inflation. We believe that inflation is set to moderate over the next year, but the timing and degree of improvement in the shorter-term are likely to keep equities volatile.

It is important to keep the current market weakness in perspective. Recessionary bear markets decline 33% over 13 months on average – but the S&P 500 is down 25% over 9 months already. Fed tightening will work with a lag on the economy – we expect weaker economic growth and earnings growth ahead. But we do not expect a deep recessionary bear market like 2002 (dotcom bubble) and 2008 (financial crisis). Banks are well-capitalized, Tech fundamentals are real, and supply has been hard-pressed to meet demand this cycle. As such, we do not see widespread excess on corporate and consumer balance sheets. Because of this (accompanied by our expected improvement in inflation), we believe this recessionary bear market to be more of the mild, average variety. The current weak trend could certainly persist for the next several months with additional downside, but the majority of this bear market is likely behind us at this point.

Technically, the S&P 500 is bouncing strongly from support in the low 3500s today (~16x P/E), which will be the initial area to watch in the short-term. Below this, the next area of key support is 3394 which was the pre-Covid highs – interesting to think that the market may completely round-trip performance since Covid (surging higher on enormous stimulus and now declining as the Fed takes it away). In a worst case scenario, we could see the S&P 500 move all the way to 3000-3200 (in line with the average -33% recessionary bear market decline historically and a 14x P/E). But the market is oversold enough to bounce at any point. Another key catalyst at the individual stock level is Q3 earnings season (beginning tomorrow with the banks). We expect dampened guidance, but it will be interesting to see the market reactions (as a gauge on how much negativity is already built in).

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