Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The S&P 500 has continued to climb higher over the past week, with incremental optimism on therapeutics and a relatively good earnings season providing fuel to the momentum. The big theme this week has been rotation playing out beneath the surface, as the year’s laggards generally outperformed significantly while the year’s leaders paused. For example, the top 100 S&P 500 performers year to date thru Friday are only up 0.1% this week, whereas the worst 100 performers were up 18.3% this week. Sector leadership was decidedly cyclical with Energy, Financials, Materials, and Industrials all making up ground. Additionally, the small caps have gained 10.4% this week, finally showing some outperformance vs. the large caps. We view this as healthy, as participation broadens out (supporting the intermediate technical backdrop).
Q1 earnings season has also been supportive with fairly positive results (ex-Financials). The banks have taken large loan loss provisions (as precaution), which investors have not rewarded. The average Financial stock has traded -0.6% lower on its announcement, whereas the average S&P 500 company (ex-Financials) has traded 1.4% higher. The best reactions have generally come from the more tech-oriented names, as the average Technology stock has beaten earnings estimates by 8.4% and rallied 2.7% on the results. This is important given the Technology sector’s market leadership and large weighting within the S&P 500. With Q1 earnings season at the halfway point, the S&P 500 is now expected to see a -16% earnings contraction for the full quarter. Many companies have withdrawn guidance (due to uncertainty), however the consensus earnings estimate is now for a -35% earnings contraction in Q2, followed by directional improvement in Q3, Q4, and into 2021. Our 2020 S&P 500 earnings estimate remains $130 (-20% growth y/y), followed by $160 in 2021 (+23% y/y) in our base case outlook.
Record monetary and fiscal stimulus are outweighing the dramatic economic impact in the short term, as investors discount the eventual recovery. A plateau in new cases and hospitalizations, along with incremental positives on therapeutics and testing capacity are all supporting investor optimism. But while the 31% rally over the past 26 days has been impressive, valuation has gotten lofty considering the challenges and uncertainty of the trajectory and timeline of the economic recovery. The S&P 500 now trades at a forward P/E of 20.3x (vs 19.1x at the 2/19 market peak). On a technical basis, the S&P 500 is testing resistance at the 61.8% Fibonacci retracement level of the 2/19-3/23 selloff with the downward-trending 200 day moving average of 3005 just overhead. Therefore, our short term bias is to the downside. We expect more attractive risk/reward opportunities to present themselves in the coming months, and thus would reserve some buying power to take advantage of such periods.
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