Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The S&P 500 has rallied ~15% from the lows in mid-October, underpinned by better-than-expected inflationary reports over the past week. Last Thursday’s CPI reading of 0.27% m/m came in well below consensus estimates, providing a welcome sign to investors that improving leading indicators (on inflation) could finally be showing up in the actual, hard data. This feeling of promise was supported by the Producer Price Index this week, which showed core PPI (ex-food and energy) flat in October – not only well below the 0.4% estimate but also following a downward revision to the September reading.
The better inflationary data resulted in lower Fed expectations, sharply lower bond yields, and higher equity markets – with clear rotation from this year’s winners into the biggest laggards. For example, some of the more Consumer and Technology-oriented areas are up over 10% in the past week while some of the more defensive areas are relatively flat. We believe this action provides a glimpse of what will transpire over time, as the market eventually turns out of the current bear market on lower inflationary pressures. Of course, timing and risk tolerance are very important because these areas will also likely underperform in another down-leg for the market.
While the better inflation data and underlying technical improvement are encouraging, we expect more time and challenges ahead before equities can show durable upside. The Fed shift to a more forward-looking approach to rate hikes is a positive development, taking into consideration the cumulative effects of basis points (bps) of tightening already this year working with a lag on the economic outlook. Accordingly, we believe the Committee will reduce its pace of hikes in December to 50bps. However, the Fed is still in tightening mode and inflation may take time to show definitive evidence that it is indeed declining to a more reasonable level.