The last week of increased market volatility and price declines is consistent with our expectations of some short-term market consolidation. With the S&P 500 trading near 2-standard deviations above its 200-day moving average, and the current market surge at the top end of previous historic recoveries (below chart) it would not surprise us to see the correction that started last week persist for a while.

However, at this point, we would not view this correction as a signal to meaningfully reduce our equity exposure but instead, will be alert to any decent pullback to add to positions in cyclical sectors such as Energy, Financials, Materials, Industrials and REITS.

Simply put, the usual list of metrics we track to signal a big bull market top is simply not present currently – inflation remains low, corporate credit spreads are tight, earnings expectations are being revised upward, and both the Fed and ECB all-but-assured us last week that they would remain accommodative for a long time to come. Robust savings and the sheer amount of government spending poised to be dropped into the economy this year will likely make any short-term softness in economic data due to the virus short-lived.

37% of the S&P traded to a 1-month low last week. That remains short of the 50% threshold that historically signals a corrective low is in sight (in market uptrends). However, while it may be too early for the Index, the 20-day lows are at 58% for Industrials, 57% Materials, and 53% Consumer Discretionary… these may be closer.

The current correction underway in the more cyclical sectors has been more meaningful and, in our view, more the result of a short-term reversion of the significant money flow into these sectors since November than representative of a more pessimistic outlook for a global economic recovery. The charts below show that the corrections in the equity values of the Energy and Financial sectors have not been accompanied by any deterioration in their credit metrics (normally a precondition for a more substantive decline).

Of note has been the improved relative performance of our holdings in the Retail and Office REITS – some of the worst performers in 2020. Investor sentiment to this sector remains overly pessimistic – REITs were one of just two sectors to actually see ETF outflows in 2020 and the % of total analyst buy recommendations placing 20th out of 24 S&P industry groups. This skeptical backdrop comes at a time when traditional cyclical sector positioning has become temporarily oversaturated, presenting a highly attractive entry point to gain exposure.


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