Raising, again, our equity exposure Raising, again, our equity exposure http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\mountains-autumn-sunrise-small.jpg November 10 2020 November 10 2020

Raising, again, our equity exposure

Vaccination hopes add to factors favoring stocks.

Published November 10 2020
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Bottom line Bolstered by vaccine news that added to budding tailwinds already favoring stocks, Federated Hermes has raised its exposure to equities for the second time in a week. Specifically, we increased the allocation to international developed stocks from a 1% underweight to neutral in our PRISM® stock-bond model, pushing the model’s overall equity weight to 58% versus a neutral 54%—40% of the maximum overweight. A further lowering in the underweight to domestic government/agencies funded the move, as a strong post-election rally in risk assets has pushed Treasury yields above a recent tight trading range. Indeed, with expectations the benchmark 10-year could hit 1.25% next year, the duration target was dropped below neutral.

Vaccine news a game-changer

Pfizer on Monday announced 90% efficacy for the coronavirus vaccine that is in Phase 3 human clinical trials with joint venture partner BioNTech. This is astoundingly positive, and we continue to believe the FDA likely will approve Pfizer’s Covid-19 vaccine shortly. In addition, Moderna is using a similar approach in its vaccine tests, so the FDA may have two promising drugs to approve before year-end. Pfizer already has produced tens of millions of doses in anticipation of FDA approval, so we soon may have limited emergency use of this vaccine. 

Because these vaccines require two doses to be administered to patients 21 days apart, early doses almost certainly will go first to front-line health-care professionals, followed by first responders and then the elderly and to people with immunological issues. But as Pfizer, Moderna and perhaps several of the other four drug companies currently in Phase 3 clinicals (an Oxford University/Astra Zeneca joint venture, Novavax, Johnson & Johnson, and Merck) receive FDA approvals and ramp up production over the course of next year, we should begin to achieve critical mass. This collectively will help to boost business and consumer confidence, normalize economic activity, increase hiring and spending, and ultimately increase economic and corporate profit growth.

Economic & corporate earnings improvement

In conjunction with successful vaccine developments—long an important part of our bullish thesis on the economy and the financial markets—last week’s election results appear to have given former Vice President Joe Biden a close Electoral College victory without the anticipated Blue Wave down the ballot. In fact, Republicans sharply reduced the Democrats House majority and most likely will end up maintaining their Senate majority, making improbable a potential fiscal policy regime shift to the left in the form of higher taxes and regulations. This helps explain why the S&P 500, which had declined by nearly 9% from Oct. 12 through Oct. 30 as investors priced in the prospect of total control by the Democrats, has rallied 13% over the past seven trading days, capped by Monday’s big move on the vaccine news.

Another catalyst: a strong earnings season. We’re roughly 90% of the way through third-quarter reports and the results are much stronger than expected for the second straight quarter. Consensus expectations called for a 21% year-over-year decline, but earnings have dropped by only 6.5% to date, with 84% of the companies that have reported beating consensus estimates by a surprising 19.2%. That’s the second-best beat rate on record, trailing only the second quarter’s 22.5% beat rate. With Blue Wave and Covid concerns dissipating, we recognize our annual earnings-per-share estimates and S&P target prices are too low and thus have raised them, respectively, from $125 to $150 and from 3,500 to 3,800 for 2020; from $155 to $180 and from 3,800 to 4,200 for 2021; and from $175 to $200 and our from 4,300 to 4,600 for 2022. 

Low-hanging fruit

From the market’s March 23 bottom through Monday’s rally, the Russell 1000 Growth Index (RLG) has surged by an overbought 72.3%, led chiefly by such domestic large-cap tech stocks as the FAANGs and Microsoft. We cut this asset class back from overweight to neutral in our stock-bond models in mid-August, after which time it’s treaded water. But over this same period (the March low through Monday), international developed stocks as measured by the MSCI EAFE Index have risen by only 48.4%, trailing RLG by nearly 24 percentage points.

Believing that performance gap between international developed and domestic large-cap stocks should narrow as the recovery improves and the virus wanes, this week’s shift took the former value-oriented asset class from a slight underweight to neutral. Domestically, the Russell 1000 Value Index has risen by 53.1% on a total-return basis over this same eight months, trailing RLG by 19 points. So, we elevated this asset class to neutral in mid-August and again to a 1% overweight last week. The Russell 2000 small-cap index has surged by 71.5% since March 23, trailing RLG by about a point. We have maintained a 1% overweight in small cap the entire cycle.

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Tags Equity . Coronavirus . Politics .

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.

Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

FAANGs is the acronym for Facebook, Amazon, Apple, Netflix and Google aka Alphabet stocks.

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

MSCI Europe, Australasia and Far East Index (EAFE) is a market capitalization-weighted equity index comprising 21 of the 48 countries in the MSCI universe and representing the developed world outside of North America. Each MSCI country index is created separately, then aggregated, without change, into regional MSCI indices. EAFE performance data is calculated in U.S. dollars and in local currency.

Russell 1000® Growth Index: Measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Investments cannot be made directly in an index.

Russell 1000® Value Index: Measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. Investments cannot be made directly in an index.

Russell 2000® Index: Measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. Investments cannot be made directly in an index.

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.

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