Buy on weakness Buy on weakness\images\insights\article\business-team-meeting-small.jpg February 2 2021 February 2 2021

Buy on weakness

Federated Hermes adds to stock-bond model equity overweight.

Published February 2 2021
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For the fourth time in four months, Federated Hermes has raised the equity overweight in its PRISM® stock-bond model, adding to large-cap value stocks for the second month in a row. The moves raised the overall equity allocation to 60%, six points above neutral and nearly 94% of equities’ allowable maximum weight of 64% in the portfolio model. At an 18% allocation, large-cap value stocks represent the largest overweight, three points above their neutral 15%.

The changes, made late Monday, were funded by reducing the allocation to domestic mortgage-backed securities another point to an underweight 5%, two points below a neutral 7%. This lowered the overall fixed-income allocation in the stock-bond model to an underweight 25% vs. a neutral 32%. The model’s strong tilt toward equities reflects expectations for a stronger recovery as vaccination distribution widens, more fiscal stimulus arrives and pent-up demand picks up, and a belief that bond yields likely will continue to grind higher. As of Monday, the 10-year Treasury yield had more than doubled since August to 1.08% and we think it could reach 1.50% over the course of year as the economy continues to strengthen.

Buy on weakness

Monday’s moves came after the S&P 500 plunged more than 4% off last Tuesday’s record high over the remainder of last week—the market’s deepest losing streak since October—due to some exogenous trading noise. Reddit’s WallStreetBets trading forum encouraged small retail investors on Robinhood Market’s brokerage platform to purchase a dozen or so thinly traded, small-cap stocks, including GameStop, a popular short target of several hedge funds. But from $43 on Jan. 21, shares in this specialty retailer that sells electronic games surged by more than 11 times to $483 in the subsequent four trading days as hedge funds scrambled to cover their outsized short positions.

This temporary dislocation spilled over into the broad equity market, with domestic large-cap value stocks underperforming growth by 4% over the past two weeks, prompting our decision to add to value. Stocks ultimately trade on fundamentals, so when the dust settles in the coming days and weeks from the Reddit, Robinhood and GameStop nonsense, we believe that the recent valuation imbalance will be corrected and that equities will resume their longer-term trend higher. GameStop, for example, already has plunged to $225 over the past three trading days and was down further this morning at $114 as of this writing.

As we consider the equity market over calendar 2021, we continue to believe longer-term fundamental tailwinds will elevate the S&P to our year-end target of 4,500, for total-return potential of 20-25%. We see these as key drivers: 

  • Peak in coronavirus infections Although Covid-related deaths now tragically exceed 400,000, infections and mortalities appear to have peaked from their expected post-holiday surge into mid-January, declining sharply over the past three weeks.
  • Vaccine rollout After a sluggish start in December, we were vaccinating roughly 1.1 million people each day in the U.S. by mid-January. President Biden assures us that we can continue to vaccinate at least 100 million people over the next 100 days. At a pace of 1 million per day, Biden says we can expect 300 million vaccinations by October. We’re already distributing Pfizer/BioNTech’s and Moderna’s two-shot vaccines in the U.S., and Astra Zeneca/Oxford University’s vaccine has been approved in both the U.K. and in Europe, with U.S. approval expected relatively soon. Johnson & Johnson’s 1-shot vaccine should also be approved later this quarter in the U.S. As a result, the combined success of Operation Warp Speed and the smoother vaccine distribution in January and beyond should allow us to approach critical mass and herd immunity by the summer. This will help to boost business and consumer confidence, which will increase hiring and spending, and ultimately increase economic and corporate profit growth.
  • Easy year-over-year comps Economic and corporate profit growth will be very easy to beat for the next few quarters, which should help boost stock prices. We’re about halfway through the fourth-quarter reporting season, for example, and results have been quite strong. We were bracing for consensus expectations of a 9-10% year-over-year (y/y) decline in earnings per share. Instead, earnings have risen by 3.1% y/y thus far, and 81% of the companies that already have reported results have beaten expectations by an average of 17.4%. That’s the third-strongest beat rate in history, trailing only the 23.2% and 19.4% beat rates in the second and third quarters of 2020, respectively.
  • Fed remains anchored at zero Chair Powell has assured us that the fed funds target rate will remain zero-bound through at least the end of 2023. Even though his current term as Fed Chair is up in less than a year (January 2022), we see no cause for concern on the benchmark funds rate during calendar 2021.
  • Washington honeymoon Despite the evenly divided Senate, we still expect President Biden will reach across the proverbial aisle with Republicans to craft a successful fiscal stimulus honeymoon compromise. That resultant sugar high will help to boost the powerful cyclical recovery that’s been underway since the recession ended in May or June of last year.

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    Tags Equity . Markets/Economy .

    Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

    Past performance is no guarantee of future results.

    Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

    Diversification and asset allocation do not assure a profit nor protect against loss.

    Growth stocks are typically more volatile than value stocks.

    PRISM® is a registered trademark of FII Holdings, Inc., a subsidiary of Federated Hermes, Inc.

    Small-company stocks may be less liquid and subject to greater price volatility than large-capitalization stocks.

    S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

    Stocks are subject to risks and fluctuate in value.

    The value of some mortgage-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations.

    Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

    Federated Advisory Services Company