Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Equities continue to trade in a rather boring sideways manner following a pause in the rate of ascent since mid- April. This is a normal period of consolidation, but it does make the market somewhat more vulnerable to negative headlines, with the latest being inflation. However, it does seem the bond market is much less anxious about run-away inflation than equities as yields and market-implied inflation expectations have moved lower since the report on May 12th of core CPI of 3%, in-line with our expectation that "hot" inflation will be transitory. This slight reprieve in inflation expectations/interest rates moving higher has provided some support for equities to move off oversold levels. In the very short-term, MACD recently reversed higher and the S&P 500 is turning up from oversold levels, which could lead to some upside towards the upper end of the recent trading range towards the ~4240 high.
We place the highest odds that this sideways trading environment will continue over the next few weeks/months with sector rotation under the surface. Given that the market is vulnerable to negative headlines, such as inflation, we do not believe the market likely runs away to the upside meaningfully (although our second highest odds are that the market has a breakout and modest rally towards our bull case price target of 4400 (~+4% from current levels). We see the 50% retracement level of 3966 as an area of support followed by the 61.8% retracement at around 3900. However, in the second year of bull market rallies from the bottom, markets are vulnerable to more “normal” corrections with the average drawdown in the second year of 12.9%. If selling becomes more intense on troubling headlines, we could see a drawdown towards 3739 (200-DMA) followed by 3735 (12% decline from the peak) and 3600 (which was meaningful breakout support).
During bullish environments (such as now), accumulating during the basing phase is warranted. For those looking to put new money to work, we recommend using periods of weakness as buying opportunities as the sector pulls back off overbought levels, similar to what we have seen in the Consumer Discretionary space this week. Conversely, we would use periods of strength to lighten sector concentrations when it becomes overbought. Our favored areas would be large value over large growth (although certain momentum indicators allow for short- term gains in growth); accumulating small-caps as they are in a basing period; and globally, we would favor the US while waiting for an opportunity in Europe and be selective in Emerging Markets as China remains weak.
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