Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Equities are bouncing to begin the new year, buoyed by the past week’s December jobs and Consumer Price Index (CPI) reports. Nonfarm payrolls rose by a still strong 223,000, but investor focus was on the 0.3% wage growth reading that came in below expectations – a welcomed sign as moderating wage growth should ease inflationary pressures. Additionally, December core CPI rose by 0.3% m/m, which brings the 3-month annualized rate down to just 3.1% (from 7.9% last June). The net takeaways for monetary policy are that the Federal Reserve (Fed) still has more work to do but likely can scale back its pace of rate hikes (as inflation is still elevated). Depending on the data ahead, the Fed may be able to stop hiking rates near 5% (from 4.5% today). But the Committee will also be reluctant to cut rates until inflation is clearly on a sustainable path to its target of ~2%, avoiding a potential repeat of the stop-and-go policy that spurred stagflation in the ’70s. The Fed wants to end high inflation while they can with a hike-and-hold policy this time in our view.
A major catalyst for individual stocks will be Q4 earnings season, which kicks off January 13 with the banks. We expect lackluster results for S&P 500 earnings (with economic leading indicators contracting), but the focus will be on forward guidance, what is baked into that guidance (economic expectations), and the market’s reaction to results. Whereas market weakness into Q3 results may have set up stocks for positive reactions last quarter, the average S&P 500 stock is now 16% off its lows and weak earnings may be more of a headwind this reporting season.
Lower valuations were the major influence on equity market returns in 2022, as stocks discounted earnings weakness to come. Now that earnings estimates are declining (which we expect to continue), the question becomes how much negativity is priced in? We have yet to see that capitulation (“throw in the towel”) moment that can sometimes occur at the end of bear markets – where valuations briefly reach depressed levels. However, multiples have contracted 41% from their peak already and may have already seen their lows. With this in mind the overall market trend may become more sideways, and our long-term positive outlook lends itself to using weak periods as opportunity.
Technically, we believe the pattern of lower highs and lower lows in 2022 will be broken, as the downtrend becomes more range-bound (potentially ~3700-4300) over the coming months. The chance of breakouts is increasing (many stocks are shaping up technically), hence the potential to move up to 4300 at some point. On the flip side, even if 3700 is broken on the downside, we do not currently feel that a new low will be established. Our rationale comes from inflation readings that are likely to improve (which can lead to rally periods), but also remain volatile. Upside inflation throughout 2022 likely becomes moderating inflation in 2023. Market trends will improve on this, but it will also take some time before we know if high wage growth and inflation are moving down to the Fed’s target (jobs are a lagging result of tightening). Therefore, double digit declines are still a high probability as investor sentiment can shift rapidly.
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