Locking in near-term profits Locking in near-term profits http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\money-padlock-small.jpg April 21 2020 April 21 2020

Locking in near-term profits

Expecting challenging fundamental news in coming weeks, we pared our allocation to equities.
Published April 21 2020

Bottom Line The Federated Hermes’ PRISM® asset allocation committee met virtually yesterday and reduced our equity overweight from 4% to 3% in our moderate growth portfolio. We decided to lock in some near-term profits due to the S&P 500’s sharp rebound over the past month and the prospect for challenging fundamental news in coming weeks.

After plunging 35% from its record high on Feb. 19 to its recent low on March 23 (the fastest decline from a record high to a bear market in history), the S&P rebounded nearly 31% through yesterday, marking its fastest recovery since 1933.

With the U.S. economy in a recession and the global energy market in freefall, the recent economic and corporate earnings news has been dreadful—a brutal trend we expect to continue over the next two months. This could spark some near-term consolidation in stock prices of about 10%.

On the economic front, the labor market has added an unprecedented 22 million initial weekly jobless claims over the past four weeks, and nominal retail sales in March plunged 8.7% month-over-month (m/m), the largest amount on record. Total vehicle sales in the U.S. declined 32.1% in March to 11.4 million annualized vehicles, industrial production dropped 5.4% m/m in March to its lowest level since 1946, capacity utilization fell to a new 10-year low of 72.7% in March, and the HMI builder-confidence index plunged to 30 in April from a 20-year cycle high of 76 in December. Confidence metrics have plummeted across the board.

We’re only about 15% of the way through a dreadful first-quarter earnings season, and flat revenues have generated a 15% year-over-year decline in profits, with companies missing consensus earnings estimates by an average of 5.5%. Company managements have largely withdrawn earnings guidance for the rest of 2020 due to the complete lack of visibility.

Crude oil prices (West Texas Intermediate, or WTI) had collapsed by 73% since the beginning of this year through last Friday, from $65 to $17 per 42-gallon barrel. Then things got really interesting. Yesterday was one for the record books, as the May futures contract (which expires today) plunged to a minus-$40 per barrel. That’s not a misprint. It was due to two factors. One was the perhaps 30-35 million barrels-per-day demand destruction from global government-mandated social distancing and shelter-in-place rules.

The second reason was because of an utter lack of oil storage capacity. After paying to extract and transport oil, oil companies had to pay customers nearly $40 per barrel to take May oil off their hands. In short, OPEC’s recent oil-production cuts were woefully insufficient to engineer an appropriate supply/demand balance globally. That imbalance likely will continue to exert additional downward pressure on overall economic and corporate profit growth for at least the next few months.

Against that challenging backdrop, the PRISM® Asset Allocation Committee met yesterday and agreed to the following changes:

Equity We reduced our 4% overweight to a 3% overweight:

  • Large Cap Value After a 32% rally since March 23, we reduced our allocation from a 1% overweight to a neutral weighting.
  • International Developed Because Japan and the U.K. remain under pressure, we lowered our allocation from a 1% underweight to a 2% underweight.
  • International Small/Mid Cap Due to strong growth prospects after a sharp share-price correction, we increased the allocation from neutral to a 1% overweight.

Fixed Income We maintained a 4% underweight, but with two allocation shifts:

  • Investment-Grade Corporate Bonds Unprecedented Federal Reserve policy action should backstop this asset class, so we increased our allocation from a 1% underweight to neutral.
  • International Fixed Income Due to Covid-19 fallout and weakening macroeconomic data overseas, we reduced our allocation from neutral to a 1% underweight.

Alternatives Unchanged at a neutral allocation.

Cash We increased allocation to this asset class with the 1% profit from equities, leading to a rise from neutral to a 1% overweight. That gives us dry powder to deploy back into stocks at lower valuation levels.

Bond Duration Target remains at 100% of benchmark.

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Tags Coronavirus . Equity . Markets/Economy .