Weekly market guide
Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
Short-Term Summary:
The big story to start the year has been the sharp rise in bond yields, along with the corresponding impact on market rotation. The US 10-year Treasury yield was able to break out of its recent range (above 1.7%), and we have a bias for bond yields to grind higher over the next 6-12 months as the Fed removes ultra-lenient policy and the economic recovery progresses. As this occurs, we see opportunity for participation to broaden out beneath the surface, which would not only be good for underlying technical trends but also provide opportunity in some of the more recovery-oriented areas (i.e. small caps, energy, financials, industrials, consumer discretionary). We need to see follow-through technically, but recommend accumulating favored stocks in these areas as they build on their relative momentum. Overall, the past week’s activity supports our recommendation for a balanced (between tech-oriented and more recovery-oriented areas) but pro-cyclical tilt to portfolio positioning.
The Omicron surge’s impact to economic activity remains uncertain, but we are encouraged by the relatively swift and mild nature to the variant. We remain hopeful that bottlenecks can thaw over the coming months as Covid concerns subside and production catches up with demand. This should ease inflationary pressures and, accompanied by elevated new orders as inventories get replenished, support corporate fundamentals. Q4 earnings season begins next Friday 1/14, and we expect solid results with upside to current estimates (though the level of surprise should continue to moderate). A look at the “early Q4 reporters” is consistent with this thinking, as 81% of the companies are beating earnings estimates by 6% (above 15-year averages of 69.5% and 5.3% respectively).
Additionally, the Fed entered early discussions of “policy normalization” this week- not only raising interest rates but also reducing the size of its balance sheet. Positively, this shows that the Fed is very mindful of the yield curve, as allowing assets to runoff while short-term rates rise may decrease pressure on the curve. We believe the risk of over-tightening at this stage of the recovery remains low. But given that Fed policy has been a key influence on equities post-credit crisis, the hawkish pivot from ultra-lenient policy may also come with a moderation in market returns along with normal choppiness/volatility over the coming year. While the potential for more meaningful draw-downs increases as the Fed transitions to raising rates and reducing the balance sheet, other factors will need to join in to trigger weakness. We expect overall conditions to remain healthy and would use pullbacks or rotation as opportunity.
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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.
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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.
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