Maintaining Bullish View; Financials and Energy Upgraded
Is anyone else tired like me after this week’s trading action in the S&P 500? The market started the week quite strong and rallied up about 2.7% to nicely reverse last’s week down performance. However, during the middle of the week, fears of rising interest rates began to spill over into equities and caused some down action that pulled the index down nearly 5%, which was disproportionately impacted by even larger declines by in many growthier names within Consumer Discretionary and Tech. Investors then turned their attention Fed Chairman Powell on Wednesday and his words during an online event did not calm the bond market and further pressured stocks. After flirting with a bigger selloff, the S&P 500 found energy on Friday from both the positive release of the monthly employment data release and some dovish Fed comments to end the week up for day and slight gain for the week. Lots of running to make so little progress.
At the beginning of the week, we released the results of our monthly deep dive into our sector (GICS-L-1) work and have updated our FSI Sector Allocation recommendations (please see the sector section of our website). We wanted to end the week by reiterating the main conclusions that our allocation methodology has been suggesting:
1. Traditional defensive area (HC, Staples, Utes and RE) will likely continue their underperformance of the S&P 500 and are thus Below Benchmark sectors.
2. Continue shifting toward Epicenter/Value/Cyclicals/Financials and away from Growth/FAANG
3. Do not completely abandon Growth/FAANG names, and this week’s severe price corrections with CD/Tech may be creating an opportunity to selectively add some exposure.
Getting more granular, our analysis has resulted in us upgrading the Financials and Energy sectors, which were the third upgrades for both sectors over the past five months. Despite the recent market volatility our tactical indicators are favorable, which has us aligned with our ongoing medium-term bullish stance. Also, we have lowered Consumer Discretionary from Above Benchmark to Tilt Above, however, our work still shows that there are still many favorable individual stocks within the sector. It should be noted that the sector is being overly impacted by nearly 50% weighing of AMZN, TSLA, and HD.
Based on our indicators and read on the macro environment the most important underpinnings for the overall equity market and our continued expectations for even higher highs are still in place. Although there has been some anxiety coming from the bond market, it is our view that the Fed is still likely to hold on for an extended period and the recent upward move in rates was overdone. It is our expectation that a favorable liquidity environment will endure for the foreseeable future.
Notwithstanding rumblings from the ‘Bond Vigilantes’, the rate backdrop remains near record lows and supportive of further equity gains. The real rate on the 10-yr when accounting for inflation is near-zero. We continue to reiterate that the earnings revision data for the broad equity market, which is a major part of our investment process (and has proved its worth in adding value over 20 years), is still quite healthy. Our expectations are that this remains the case as analysts and investors start shifting their focus to economic recovery and a powerful corporate profit cycle. Thus, we encourage investors to remain focused on the long-term the; 6 month, 12 month and 18 month time horizon for which readings are still overwhelmingly positive.
When looking for risks that are out there and what we watch closely, the first and main potential concern is sudden and sharp increases in interest rates and inflation expectations may remain problematic for the short-term and may return from time to time throughout the year. There are other issues that could obviously cause increased volatility like a fourth wave of COVID-19 or increasing ubiquity of the new viral strains.
The bottom line this week is that the current bout of volatility is likely creating an opportunity for investors to raise exposure in areas and specific stocks that may have begun to run away from us and to move further into the most favorable ideas that our research is flagging.
Most preferred sectors: Financials, Industrials, and Materials with Information Technology, Energy and Consumer Discretionary better than neutral
Neutral sectors: Communication Services
Least preferred sectors: HC, Utilities, Consumer Staples and Real Estate
