Weekly Market Guide
Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Short-Term Summary
This week's positive news on a potential COVID-19 vaccine has fueled a sharp rotation within the market as the relative beneficiaries of the stay-at-home environment gave way to the areas most impacted by the pandemic. For example, the underperforming industry groups year-to-date have gained 6.1% on average since last Friday, whereas all other areas are roughly flat (0.5%) on average since then. This rotation on vaccine optimism shining a "light at the end of the tunnel" is spurring questions around portfolio re-positioning toward the laggards.
Although this time the rotation may finally last, we recommend a more pragmatic approach to portfolio changes and prefer to build positions as the technical trends are sustained over time (particularly with the virus spreading rapidly right now). Our favored areas for portfolio rotation adjustments are the small caps, industrials, and materials, followed by the financials. Capital to increase exposure to these areas can come from select areas of Technology. Portfolio diversification is building importance once again, as the market becomes less dependent on a small segment of stocks that have dominated the stay-at-home environment. This not only creates more opportunity broadly across all areas of the market, we also view it as a positive for overall market strength.
Technically, the sharp S&P 500 up-move over the last 10 days (9.2%) is suggestive of above average returns over the intermediate term. After such sharp gains historically, it is normal to see some consolidation in the short term; however, moves of this magnitude are very often also followed by strong returns over the next 6-12 months. For example over the past 15 years, the S&P 500 has experienced a >7% initial move in 10 days only 20 times before this week. The average return over the next 6 and 12 months has been 14.3% and 20.2% respectively (with 88% and 94% positive rates). This compares favorably to 6 and 12 month returns in all periods of 5.3% and 10.8% respectively (with 76% and 82% positive rates).
Fundamentally, a very strong Q3 earnings season has continued the upward trend in S&P 500 earnings estimates. And while interest rates have moved marginally higher recently, the S&P 500 equity risk premium (S&P 500 earnings yield vs 10 year Treasury yield) is 3.0%. This remains historically elevated and supports our view that valuation multiples can remain lofty given exceptionally low interest rates. Since 1962 (following at least a 3% reading), the S&P 500 has seen positive returns over the next 3 years every time with an average annualized return above 8%. Headwinds remain (i.e. rapid virus spread, Senate control, size and timing of fiscal aid), but we would use pullbacks as buying opportunities for the longer term.
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Index Definitions
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market.
The MSCI World All Cap Index captures large, mid, small and micro-cap representation across 23 Developed Markets (DM) countries. With 11,732 constituents, the index is comprehensive, covering approximately 99% of the free float-adjusted market capitalization in each country.
MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations.
MSCI Emerging Markets Index is designed to measure equity market performance in 23 emerging market countries. The index's three largest industries are materials, energy, and banks.
Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.
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