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

February was a reality check for investors following January’s surge higher on “soft landing” optimism, as sticky inflationary readings over the past several weeks resulted in higher rate expectations, rising bond yields and lower equities. It is a reminder that the path ahead will be a lumpy process and that the market is not ready to sprint back to new highs. We expect choppy trading over the coming weeks and months, as investors digest the economic dataflow – and sentiment swings may occur due to elevated uncertainty on inflation, Federal Reserve (Fed) policy, and ultimately economic growth. That said, we do remain positive on equities over the next 12 months and view the recent pullback as opportunity to accumulate favored areas within a longer-term perspective.

Fed rate hike expectations have moved substantially higher as a result of the recent “sticky” inflation readings. For example, the market-implied peak Fed funds rate is now 5.46% by September versus an expected peak just one month ago of 4.88% by June. This shift in expectations is pushing bond yields higher – the 2-year yield is up to 4.95% (cycle highs) and the 10-year yield is up to 4.06% (approaching October highs of 4.23%) – which is a headwind to equity valuations.

But just as the “goldilocks” market view was unjustified, this current adjustment in the other direction may be misguided as well. The highest odds are that the normalization process (from pandemic/record stimulus) will create confusing data along the way with upside runs and pullbacks to follow for equities. Until we get some clarity regarding inflation and then the economy, a market run to new all-time highs is a low probability. But the number of technical positives over recent months also suggest that the lows of this bear market may be in. Hence, the pullback can be accumulated with a percentage of cash set aside and earmarked for equities.

• Don’t overthink Growth vs. Value – stay with diversity. If the economy does not rollover, Value may continue to lead. If the economy softens to the point to drive rates down, Growth may lead (on a relative basis).
• Mid-caps have some of the best price momentum. Small-caps are holding up and likely justify at least an equal weight. Risk of economic weakness (they suffer more) holds us back from being too bullish or overweight.
• Global – although it is tough to square with potential economic weakness ahead, the technical price momentum is difficult to ignore (despite it being driven by dollar weakness). The result is an equal weighting in-line with long-term targets- potential economic weakness keeps us from being overweight. Emerging Markets are interesting with China reopening (and pulling back).
• Bonds – 10-year yield nearing top of near-term range?

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