Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Last week’s market enthusiasm following Federl Reserve (Fed) Chairman Jerome Powell’s speech has quickly turned to focus on the sharply inverted yield curve (which continues to worsen) and hesitancy ahead of the catalyst rich upcoming week which includes important readings on inflation (PPI and CPI) along with the Federal Open Market Committee (FOMC) announcement, in which the market is expecting a 50 basis points (bps) increase, a slowdown from the recent pace of 75 bps per meeting. The sharp inversion of the yield curve is giving investors pause as sharp inversions have historically been a precursor to a future recession.
However, for now, the labor market remains strong with the unemployment rate remaining low at 3.7% and the change in non-farm payrolls of 263K topping consensus estimates of 200K. The strong labor market could continue to give the Fed cover to maintain a more restrictive monetary policy. Additionally, a major area of focus within the upcoming inflation reports will be wage growth, which remains stubbornly high given the tight jobs market, and could pressure the Fed to maintain its current restrictive stance for longer.
From a technical perspective, after improving over 17% from the October lows and despite breaking above the 200-DMA for the first time in 8 months, the S&P 500 has been turned back at the downtrend line for now, which has been in place since the beginning of the year, as short-term indicators got into overbought territory. We would continue to watch 3910 on a closing basis for support followed by 3867 (38.2% Fibonacci retracement level). If this level is unable to hold, the 3800 area (50% Fibonacci level) provides the next level of support. On the upside, a breach of the downtrend, which is currently at 4109 will be key for further upside. We would expect some continued back-and-forth volatility and would be buyers on weakness, but cautious on chasing bear market rallies.
In the past week, sectors such as Industrials and Financials have been under pressure, but we have seen strength within Health Care, which remains one of our favored sectors. Emerging Markets is another area that has seen momentum, but we would be cautious of chasing the improving relative performance with the US Dollar sitting near its 200-DMA. For the S&P 500, we continue to believe over the next year, the Fed is likely to reach the peak of the tightening cycle, which is likely to shift the focus from inflation/pace of rate increases to economic/earnings data, in which we believe there is risk that earnings for the S&P 500 could come down further. Typically, there tends to be a lag between the rate hike cycle and when the higher rates begin to impact the economic environment by 6-9 months with another 12-18 months before it will be fully realized. In this environment, rallies and sell-offs are likely as we get a better picture of the economy, but remain favorable on equities long-term.
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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
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