Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
Following its break out last week, the S&P 500 has been able to hold above the 50 day moving average (DMA) and push to within 0.5% of new highs, as trade talks continued to de-escalate this week. China exempted some goods from tariffs (for the first time since trade talks began) and is reportedly close to agreeing to US agricultural purchases. Additionally, President Trump delayed the October 1 increase in tariffs (to 30% from 25% on $250B worth of imports) by two weeks to October 15, ahead of the Chinese delegation coming to DC for talks in early October.
The previous S&P 500 high of 3027 is now the next level of technical resistance. With short term indicators reaching overbought levels, we would not be surprised to see some consolidation before pushing higher. However, the short term technical improvement lowers the odds for a move to (or below) the 200 DMA (2817) for now. Nearby support on the downside is the 50 DMA at 2950. Over the intermediate-term, we are still guarded but with a positive bias. Our reasons for caution include a low probability of meaningful trade progress, a sluggish earnings trend, and weak seasonality. However our positive bias results from the dovish Fed (25 bp cut expected next Wednesday), belief that a worst-case will be avoided on trade tensions, and the services side of the economy remains strong.
The US 10 year yield backed up 32 bp over the past week, and is now up against its 50 day moving average of 1.80%. This back up obviously comes following a total collapse in interest rates since last November (when the US 10 year yield was 3.25%), which stretched the US 10 year yield to 40% below its 200 DMA. This was the most stretched below its 200 DMA that bond yields had reached in at least the past 5 years, so the slight mean-reversion should not come as too big of a surprise. Nonetheless, the tick up in interest rates (which was actually a 15% move) was the catalyst for sharp rotation between Growth vs. Value, as well as from year to date leaders to laggards, within the equity markets this week. For example, since Friday, Large Cap Growth is flat while Small Cap Value is up 6.3%. Additionally, leading year-to-date areas like Real Estate, Commercial Services, Restaurants, Software, and Health Care Equipment all underperformed; while laggards like the Banks, Energy, Transports, and Technology Hardware all outperformed.
Given Value’s underperformance for the vast majority of this bull market (and inexpensive relative P/E), it is leading many investors to wonder if the tide is turning for Value. Looking at similar relative strength spikes in the past, prior to 2017 spikes in Value outperformance led to at least short term relative strength. However, over the past couple of years, similar spikes have not led to sustainable relative gains for Value. Thus, the trend needs to be monitored in the near term for signs that it is sustainable, but for now it is far too soon to make a major portfolio shift.
Similarly, there was a noticeable shift into small cap from large cap this week. Small caps have outperformed by over 1% for the past three days in a row. This led to sharp relative strength gains for the small caps, although the intermediate term trend is still downward. The underperformance before this week was so extreme that the move could be nothing more than regression to the mean. The sharp momentum needs to prove sustainable, and we await price and relative strength to break out.
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