Review the latest portfolio strategy commentary from Mike Gibbs.
The S&P 500 has been resilient, hanging in there at the upper end of its recent range (~4200). Investor optimism surrounding an end to the Federal Reserve’s (Fed) rate hike cycle has supported the recent strength, but we are not convinced that a steady climb higher is in the cards yet.
The delayed effects of rapid Fed tightening should bring economic growth and inflation down in the months ahead. In fact, the Fed’s own forecast is for a recession to begin later this year and inflation to reach 2% by year-end 2024. It thus makes sense for the rate hike cycle to either be at or near an end (as the market expects) – and Fed pauses have historically been a boost to equities. However, the Fed will also be reluctant to cut rates with inflation still high, unless economic damage intensifies and employment deteriorates. The Fed wants to avoid easing too early with a potential “stop and go” policy like that which plagued economic conditions in the 1970s – preferring instead a “hike and hold” strategy this time.
If economic conditions hold up, the Fed may be emboldened to tighten policy more than current market expectations – a headwind to equities in our view. For example, Fed speakers have talked tougher recently with banking concerns subsiding and equities climbing. If economic conditions deteriorate, we do believe the Fed will ease monetary policy – but economic volatility is also likely to correspond with market volatility. This results in our rangebound view on equities for now, and narrow participation beneath the surface supports this stance.
Q1 earnings season: The majority of companies have beaten estimates so far by an aggregate 6.9%. It is still early in earnings season, but market reactions have generally been counter to recent trading. For example, Communication Services (outperformed into earnings) have seen a -5.3% price reaction on average, while the Industrials (underperformed into earnings) have seen a +2.9% price reaction on average. For the S&P 500 as a whole, next 12-month earnings estimates have ticked up since earnings season began, but we are not sure this will hold up throughout Q1 earnings season. While we remain below-consensus on earnings estimates, we do believe that a lot of negative news is already priced into this bear market.
In summary: Pay attention to earnings season in the context of a market that is probably at the top of what we think is a trading range. For investors with marginal cash, we would be reluctant to spend it all at current levels. Long term investors – evidence is building (especially in a mild recession) that we have seen the lows and are in the late stages of this bear market.
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