Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Federal Reserve (Fed) Chairman Jerome Powell’s much-anticipated speech on November 30 was far less hawkish than anticipated, resulting in lower market-implied rate hike expectations in the outlook, lower bond yields, and sharply higher equities. For example, the S&P 500 and Nasdaq were up 3.1% and 4.4% in Wednesday’s trading with strong internals.
There was a sense of investor hesitancy in the lead-up to the speech with many expecting Powell to suppress the market’s optimism since the October CPI report, as the Fed does not want financial conditions to ease too early. To be sure, he discussed the high uncertainty in predicting the inflationary outlook, that inflation is still far too high, and that the Fed has more work to do (none of which was new news). However, his tone seemed more balanced between the risk management of being careful not to hike too aggressively or not enough. He all but confirmed a slower 50 basis point (bp) hike for December, and likely what got markets excited was spending time to discuss the still plausible chance of a soft landing (potential for rate hikes to hit high job openings, rather than resulting in spiked unemployment). The shift in tone to a more delicate approach is justifiably positive for equities, but we do not believe the market is ready to exit this bear market that easily.
Ultimately, the degree of inflation moderation ahead, and in turn the Fed policy, and how much damage will be inflicted on the economy (to bring inflation under control) will remain the primary influences on earnings and multiples in our view. We do believe that we are in the late stages of this bear market, due to our belief that inflation is set to moderate over the next year and that the recession will be mild. However, the Fed remains in tightening mode, tightening acts with a lag on the economy, and it will likely take time for the Fed and investors to have high conviction on the inflationary and economic outlook – resulting in more time needed before equities are able to show sustainable upside in our view. The next major catalysts include the FOMC decision and press conference on December 14, along with November CPI the prior day on December 13.
The underlying technical backdrop has improved in the second half of this year, and the percentage of stocks above their 200 DMA is now at its highest level since January. There are encouraging signs technically that market trends are attempting to become more supportive, however equities are also now overbought in the short-term (following a 17% rally since the 10/13 lows). With overbought conditions, along with expected choppiness ahead, we maintain our overall stance to refrain from chasing the rally periods and to build exposure in the weak periods.
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