Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
After closing at new bear market lows on Friday (25% from its highs), the S&P 500 has rallied ~5% to begin October. While equities were broadly oversold enough for a bounce, economic data this week has also been supportive of the move. Monday’s September ISM Manufacturing showed order backlog, supplier delivery times, and prices paid all at their lowest levels since the Covid shutdown. This moderation in pricing pressures was also reflected in yesterday’s ISM Services prices paid. Moreover, on the labor side, JOLTS Job Openings saw a 1.1M drop which was its largest ever monthly decline (outside of February and March 2020). This is a step in the right direction, as a cooler labor market should lead to slower wage growth and shelter inflation. This week’s survey-based “soft” data continues the recent trend of improvement in inflationary leading indicators, however investors need to see this follow-through to the “hard” actual data for market upside to prove durable. Next week’s September CPI and PPI readings, in addition to Friday’s September jobs report (updating employment and wage growth), will be significant catalysts on the market’s next move.
Because inflation has stayed so high for so long, it has increasingly weighed on the backbone of the U.S. economy – the consumer. Low disposable income levels and savings rates, combined with weak asset prices, are headwinds to purchasing power. And the Fed, which has come to the rescue in weak economic times over the past decade, does not have that ability right now due to its objective of bringing inflation down to a more reasonable level. Therefore, the path of inflation will remain highly influential on the economy, Fed expectations, and the market. Overall, we believe that inflation will moderate over the next 12 months, but the timing and degree are unknowns. Also, the path to improvement is unlikely to be smooth. We expect volatile data to result in volatile markets in the short-term (weeks to months), but believe the risk/reward is favorable for long-term investors from current levels.
Technically, the predominant market trend remains downward for now; but there have at least been some positives beneath the surface. As the S&P 500 broke to new lows recently, the percentage of stocks making new lows declined. This is a positive development and can be seen near market turns, as underlying breadth improves prior to price. It is also notable that relative performance of High Beta (vs Low Volatility) did not break to new lows with the market, and the more defensive areas (i.e. Utilities and Consumer Staples) have shown significant weakness lately. This could be an indication of an aging bear market, as “bear markets eventually get to them all.” In terms of positioning, we are encouraged by relative strength holding up recently in some of the more economic-sensitive areas such as the Small Caps, Technology, Consumer Discretionary, Financials, and Industrials, but more work needs to be done technically. Real rates (inflation-adjusted bond yields) and the U.S. dollar – both correlated to the economic data flow – will continue to heavily influence underlying positioning and performance.
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