Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
With ~20% of the S&P 500’s market cap having reported up to this point, Q3 earnings season has gotten off to a solid start. 83% of S&P 500 companies have beaten estimates by an aggregate earnings surprise of 13.3%. While this 13.3% rate is lower than the past five quarters, it is still very strong historically (well above the 5.2% 15-year average) and supportive of fundamental trends. Many companies are citing the difficult environment with the Delta variant’s impact on global supply chains and inflation, but also noting elevated demand. Importantly, since the start of Q3 reports, forward S&P 500 earnings estimates are ticking higher for Q4 2021 and all quarters of 2022. Earnings are the most important driver of equities over the long term, so these positive revision trends are supportive of overall market trends. Looking ahead, earnings season is set to heat up from here with 173 more S&P 500 companies reporting by the end of next week, highlighted by the mega-cap Tech names (AAPL, MSFT, GOOGL, AMZN, and FB make up 22% of the S&P 500’s market cap and all report next week).
Technically, “buy the pullback” wins again, as the S&P 500 broke above the 50-day moving average and is attempting to push to new highs. The downtrend has now transitioned to a horizontal base- more of a flat/ consolidation pattern than declining pattern, and we view it as a pause within the prevailing uptrend. Odds are the index breaks out to the upside. However, due to uncertainty surrounding the supply chain, Fed action, and inflation (labor market structure), we have a sideways to moderate upward bias over the coming weeks and months. Seasonal factors (Nov-Dec seasonally strong period of the year) and the potential for some clarity over the issues (with Delta past its peak) are next in line to produce the next leg higher. Earnings are the long-term driver of stock prices, and it is reassuring to see a solid start to Q3 earnings season being a key driver of the rally.
Declining Covid cases have supported upside in bond yields over recent weeks, which has significant implications on equity market performance beneath the surface. The improved growth expectations and less risk-off tone (following Delta’s peak), along with the corresponding steeper yield curve, bodes well for the “average stock.” The equal-weight S&P 500 index broke out to new highs yesterday, which not only supports underlying trends for equity markets (improved breadth in the rally) but also supports our positive stance on some of the more economically-sensitive areas. All in all, we recommend positioning portfolios with a diversified but pro-cyclical tilt (continuing to underweight the more interest-sensitive, defensive areas), and using weakness opportunistically.
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