Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
April core CPI jumped to 3% y/y (well above consensus estimates of 2.3%) and was more than just due to “base effects” with a 0.9% m/m price surge (highest m/m reading since the early 80's). Drastically influencing this monthly reading in our view is the swift economic reopening accompanied by enormous stimulus and supply chain shortages (creating substantial pricing power as demand far outstrips supply). For example, used car pricing was up an enormous 16.2% m/m, along with airline prices up 10.2% m/m and hotel prices up 8.8% m/m (unsustainably high numbers). This inflationary dynamic could last for months, but should abate over time as stimulus ebbs and supply chain issues get resolved. There is still plenty of slack in the labor market and productivity growth is increasing, both offsetting the sustainability of higher inflation.
Nevertheless, this “inflation scare” is creating volatility in the equity markets, particularly the long-duration growth names (i.e. technology). We ultimately believe this will prove to be a “noise event,” resulting in a buying opportunity for equities on the pullback. However, we are in one of those "noise" drawdowns right now, and it is hard to predict how far or long it will go, especially with so much algorithmic trading and factor investing. The technology sector is oversold enough to experience a relief bounce, and the S&P 500 is rebounding from technical support at its 50 DMA (4056). But the market as a whole is not deeply oversold yet, so we will need to monitor price action in the coming days to assess whether or not the current bout of volatility is over. Longer term, the overall trend remains bullish (>90% of stocks above their 200 DMA) with plenty of potential technical support levels nearby. We view this current period as a normal pullback, and would use weakness as an opportunity to accumulate favored names.
Fundamentally, robust earnings growth and positive estimate revision trends remain supportive of equities. And as earnings sharply recover, elevated valuation multiples should normalize. "Inflation scares” can create some urgency in that normalization process. Historically, the highest valuation multiples are seen in the 2-2.5% inflation range on average and begin to diminish as inflation moves north of that figure. But the recent inflation report is unlikely to waver the Fed from its accommodative stance for now. Additionally, margin estimates for 2021 and 2022 continue to move higher to new highs. And credit spreads remain very low, actually narrowing on yesterday’s April inflation readings (i.e. the bond market is not as anxious as equities). So while volatility is bound to occur and inflation concerns could be the catalyst for a moderation in the market's pace of ascent, we continue to view the fundamental positives as outweighing the negatives.
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