Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The S&P 500 is attempting to bounce after pulling in ~17% since the mid-August peak. While the predominant market trend remains lower for now, we do believe an oversold rally could transpire to the 3900-4000 area in the short-term for several reasons:
- A two-month 17% decline from mid-August to recent low is enough to produce a bounce. The two prior down waves experienced this year contracted -14% and -21%.
- Earnings season: companies do a good job of managing expectations to allow for upside surprises. Since Q3 earnings season began last week, 80% of companies announcing have beaten by an average of 2%. The average 3-day price reaction on earnings has been 0.8%. To be sure, forward estimates are still trending lower and we expect that to continue as Fed tightening acts with a lag on the economy – but a lot of negative news has already been priced in with the S&P 500 -25% off its highs. Additionally, the sharp decline of equities into earnings announcements may have been “too far, too fast” based on the actual results coming out.
- Real Yields appear to be in a basing period. The previous basing period coincided with a 19% rally from the mid-June lows to mid-August peak. As a reminder, the sharp upside in real yields experienced this year has a strong inverse correlation on market valuations and positioning.
- The S&P 500 found support near the 200-week moving average, which has been a good level over the past decade in weak periods. Although the index may undercut it ultimately as the bear market runs its course, the key support level is unlikely to fail in the first attempt.
- 3900-4000 is the 61.8% retracement level of the recent down wave and would be a 14% rally from the recent low. The two prior bear market rallies this year saw similar retracements of 11% and 17%. Moreover, the 3900-4000 price area resides between the 50- and 200-day moving average and is near horizontal resistance.
Our underlying view remains that inflation should moderate over the next year, easing strains on monetary policy, bond yields, and equity valuations. However, the timeline of this improvement remains uncertain in the shorter-term, and volatile economic data is likely to correspond with volatile markets for now. Despite this, we believe a lot of economic and earnings downside is already priced in at current levels. Recessionary bear markets go down 33% on average over 13 months, but the S&P 500 is already down 25% over 9 ½ months. With this in mind, we recommend investors maintain focused on the long-term bull market opportunity from current levels, despite the elevated likelihood of further volatility over the coming weeks and months.
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