Markets in Focus

Timely analysis of market moves and sectors of opportunity

July 15, 2024: Any further rotation depends on earnings

Key points

  • As earnings season picks up, any further rotation in equities will hinge on how much earnings growth companies manage to deliver.

  • In the wake of an encouraging Consumer Price Index report, Matt Orton, CFA, sees a higher probability of the first interest rate cut coming in September.

  • Don't forget mega-cap stocks just yet: They could have more room for upside should their earnings results come in ahead of expectations.

 


 

The average stock in the S&P 500 Index finally managed to outperform the behemoths, but two days does not make a great rotation.

Thursday, July 11, represented a stunning reversal of the recent trend of concentrated positive returns, as 396 stocks in the S&P 500 closed higher on the day.1

“As far as I can make out, that's an all-time high for the number of S&P 500 single names that have rallied on a day when the index declined,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

It also was only the ninth time when the Russell 2000® Index rallied more than 2% while the S&P 500 ended negative. Still, Orton said he would be careful extrapolating some of the sharp reversals we saw after the Consumer Price Index (CPI) was reported into a “great rotation.”

Instead, he said much of the price action on Thursday was likely the result of position squaring rather than portfolio reallocation: for example, the unwinding of the short small-cap or long technology trades. We are also entering the busiest few weeks of earnings season, and he said any further rotation will depend on company fundamentals delivering. The average stock is expected to deliver its first quarter of earnings per share (EPS) growth since the fourth quarter of 2022, while the Magnificent Seven are fighting the law of large numbers and their year-over-year EPS growth is again expected to slow.

“Earnings growth has already broadened over the past two quarters, and this backdrop could help the earnings breadth we've been seeing finally translate into the increased price breadth so many investors have been looking for,” Orton said. “Fundamentals clearly matter and consequently selectivity will be critical with elevated expectations coming into earnings season.”

Orton has advocated for investors to build better balance in their portfolios, and he said the economic data coupled with the price action last week shows why that is important.

“Investors can and should consider continuing to own what has been working,” he said, “but there are plenty of opportunities to own high-quality businesses where earnings are inflecting higher, which I believe should support further rotation in the market.”

Thursday's sharp reversals were precipitated by the June CPI report, which was clearly positive from an inflationary standpoint. Headline and core CPI surprised to the downside for the second straight month, with the details overall supporting a softening inflationary trend. While a few categories delivered chunky declines, the move down was broadly based. In particular:

  • Non-shelter services inflation cooled with recreation services and transportation services excluding auto insurance and airfares contracting and inflation in medical care services decelerating.

  • Rental of primary residence and owners' equivalent of rent of primary residences (OER) also cooled to the slowest levels since 2021, making this an unambiguously good report on the inflation front.

“The market has largely pulled forward expectations for the first interest rate cut to occur in September,” Orton said, “and while I agree that the likelihood for a September cut has increased meaningfully, it's still a bit premature to be expecting more than 50 basis points of cuts this year.&lrdquo;

There are two more CPI reports before the September Federal Open Market Committee (FOMC) meeting, and the labor market remains in pretty good shape. Orton said it's worth noting that part of the relief rally in cyclicals and small caps was not only the result of falling rates, but also the increased acceptance that a soft landing is probable.

“At the end of the day, earnings will be the vital to sustained change in the key drivers of the market,” Orton said. Second-quarter earnings are off to a decent start, with EPS growth at 9.4% for the 5% of S&P 500 companies that have reported so far. But he noted that the details of the results we got from the big banks weren't glowing: There is a continuing gap between high and low credit customers, and more money is being set aside for bad loans. One chief financial officer at a money center bank noted that this represents “normalization, not deterioration,” and Orton said it's in line with expectations. This week will bring more color as the earnings focus remains on financials, particularly regional banks.

S&P500 Closed higher

Source: Bloomberg; as of 7/12/24.

“If we can see strong results and guidance from companies down the market-cap spectrum as well as in sectors that have underperformed year to date, that could be the catalyst we need to provide a bid to the average stock,” Orton said. “But dispersion has been and will likely remain high, especially during earnings season where investors have little tolerance for anything less than perfection. This is why selectivity is so critical.”

What's on your to-do list?

“I believe building balance should be the top of every investor's to-do list right now,” Orton said. “That doesn't necessarily involve trading technology for value, but it does mean looking more closely at opportunities across higher-quality cyclicals. The continued decline in yields and increased likelihood of an additional rate cut this year should have anyone with large cash reserves seriously questioning why they haven't started to implement a plan for redeploying capital.”

Yes, he said, the S&P 500 might be trading near all-time highs, but the moves at the end of last week, coupled with historic price action in different parts of the market, mean that there are still plenty of opportunities. Orton's playbook for the second half of 2024 keeps a focus on higher-quality companies across his favored areas of the market:

Orton's investment playbook


Orton's investment playbook

  • Revisiting AI 2.0. “I continue to believe the best way to get leverage to the artificial intelligence (AI) theme outside of the best-in-class semiconductor names is through the beneficiaries from the growth of capital expenditures,” Orton said. Monetization of AI is likely to take longer than initially hoped for, but hyperscalers are aggressively investing in AI. Last quarter, just four of these companies announced plans to spend nearly $200 billion over the next 12 months, and he said the consensus continues to expect a meaningful increase in this amount from even more companies. He doubts that investments will be scaled back even if the monetization of AI is pushed out, so pay attention to areas of interest during earnings calls. Orton continues to favor semiconductor capital equipment companies and industrials as a way to play this theme. Massive investments will also need to be made to provide enough power for the buildout of data centers, which sharpens the focus on best-in-class electric utilities and sustainable power generators.

  • Is the rally in small caps sustainable? It's too early to tell, Orton said. On July 11, Russell 2000 small caps had their third-strongest gain relative to S&P 500 large caps since 2000. Other surges of similar size started recovery rallies in October 2011 and March 2020, but given the current economic backdrop and multi-year performance lag, Orton thinks it will take a solid earnings season to get sustainable movement down the market cap spectrum. He said investors first must see and then believe that small-cap earnings can grow faster than large caps at some point in the next 12 months and can maintain that relative earnings advantage. With the expected start of monetary policy easing having been pulled forward, the rate backdrop for small caps should improve and also pose less of a psychological headwind for investors, he said. This, coupled with the tailwinds from the unwinding of money market funds, which had $6.1 trillion in assets under management as of July 11, 2024, according to the Investment Company Institute,2 could help start to put small caps on more solid footing.

    “There are still a lot of question marks,” Orton said, “but I maintain that the risk-reward looks favorable, especially for those who can live through any potential near-term volatility.”

  • We're not done with the mega-cap stocks, yet. While the pressure at the top of the market following the June CPI report was stark, Orton suggested waiting for earnings to see whether there will be a sustainable rotation. The Magnificent Seven are still expected to have EPS growth in excess of 30% and their secular growth tailwinds aren't really tied as closely to the normalization we're seeing in economic growth, he said. Additionally, if this group of stocks remains under some pressure heading into earnings releases, he said this actually could provide them with a buffer and more room for upside should their results come in ahead of expectations. Also, with the Citigroup Economic Surprise Index continuing to decline, he said the level of quality growth that these companies offer could provide ballast for investor portfolios.

What to watch

The spotlight shifts somewhat from monetary policy to second-quarter earnings, with results from several major names, as well as most regional banks.

Meanwhile, there is a packed slate of U.S. Federal Reserve speakers ahead of the FOMC's pre-meeting blackout period, plus June retail sales on Tuesday and initial jobless claims on Thursday.


% of S&P 500 sector by market cap reporting earnings per week
% of S&P 500 sector by market cap reporting earnings per week

Source: Bloomberg; as of 7/12/24.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of July 12, 2024.

2 Money Market Fund Assets, July 11, 2024, Investment Company Institute: https://www.ici.org/research/stats/mmf

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Link(s) are being provided for informational purposes only. Raymond James Investment Management is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James Investment Management is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
Ballast, in finance, can refer to characteristics, factors or trading strategies that mitigate volatility or provide stability to a security, group of securities, or portfolio.

Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

The Citigroup Economic Surprise Index tracks the relationship between economic data and economists’ expectations for a range of economies. A positive reading means that data releases have been stronger than expected, and a negative reading means that data releases have been worse than expected.

The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’' and dentists' services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.

“Core inflation,” as measured by the CPI's “All Items Less Food & Energy” category is an aggregate of prices paid by consumers for a typical basket of goods that does not include food and energy. Core CPI is widely used by economists because food and energy typically have very volatile prices. Headline CPI inflation includes food and energy.

Contrarian investing is term used to describe the decisions of investors who intentionally go against prevailing market trends, buying when others sell, and selling when others buy.

Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.

Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.

Dividend payers are the companies that distribute a portion of their profits to shareholders in the form of a dividend.

An earnings inflection marks a sudden change in the direction and rate of change of earnings growth. Earnings inflections can lead to either positive or negative change.

Earnings per share (EPS) is calculated as a company's profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.

Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

Headwind is a term used to describe events or market forces that hinder the prospects for performance in an individual investment or group of investments.

Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.

The law of large numbers is a concept from probability and statistics that holds that as a sample size grows, it tends to approach the average of the entire data set being examined because the sample becomes more representative of the whole as it grows larger.

A long position refers to the purchase of a security with the expectation that it will rise in value, reflecting a bullish attitude.

The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. At that time, they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.

Market capitalization, or market cap, refers to the total dollar market value of a company's outstanding shares of stock.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

Money center banks are large banks situated in economic hubs that primarily deal with governments, other banks, and big corporations.

The owners' equivalent of rent of primary residences (OER) is a component of the Consumer Price Index that helps measure changes in the cost of shelter in the United States. It is based on the answers from consumers who own their homes to the question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Provide a bid is a phrase used in finance to describe the development of favorable conditions for investing in a particular security or group of securities.

Quality investing is a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance, as reflected in financial metrics such as ratios of return to equity and debt to equity, as well as to earnings variability.

A relief rally is a break from a wider selloff in a market that sees a temporary increase in security prices. Relief rallies can be triggered by news or data that turns out to be better than expected or first believed. An extended rally can be called a recovery rally.

Reshoring describes an effort to bring manufacturing and other services back to the United States from overseas operations.

Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

A short position refers to a trading technique in which an investor sells a security with plans to buy it later.

A soft landing is a cyclical slowdown in economic growth that avoids a recession.

A square position refers to eliminating exposure to market risk and is normally achieved by closing out all existing positions.

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment's performance.

Unwinding describes the process of closing out what is often a large or complicated trading position.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company's express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

 

M-575653 Exp. 11/15/2024


July 8, 2024: Lean into what’s working

Key points

  • Quality and momentum are working. S&P 500 Index companies that are performing well generally have strong secular growth tailwinds that are contributing to an acceleration in earnings, free cash flow, and margins.

  • Are jobs numbers worse than they appear? Not likely, says Matt Orton, CFA.

  • Watch for second-quarter results to build on the rebound of the past two quarters.

 


 

The bull market is alive and well with the S&P 500 Index pushing to new all-time highs despite a continuation in narrow leadership at the top.1

Last week, the Magnificent Seven contributed 90% of the S&P 500’s 2% gain with only 14% of constituents outperforming the broader index and only 40% finishing in the green. The degree of narrowness in this market is constantly criticized and cited as one of many reasons that investors should be wary of the market.

“I have never agreed with that logic and believe that investors should continue to embrace what has been working: quality and momentum,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

That includes the mega-caps, but Orton noted that there are many quality companies outside of the Magnificent Seven that also are performing well. More than 20% of S&P 500 constituents are outperforming the index year to date, and they represent a diverse set of sectors and industries. What they all generally share are strong secular growth tailwinds that are contributing to an acceleration in earnings, free cash flow, and margins.

Orton said it’s also worth noting that it’s not only the U.S. markets that are making records: International developed equities have also been strong with Japan’s Nikkei 225 making fresh all-time highs alongside Europe’s ongoing recovery while the MSCI Emerging Markets Index rose to a new 52-week high thanks to strength in Asia outside of China.

“All of this gives me confidence that equities can continue to move higher, but earnings growth will have to continue to deliver and surprise to the upside,” he said. Earnings season kicks off in earnest with the big banks on Friday, and Orton said, “I hope the expansion in earnings breadth that we’ve seen over the past two quarters will continue and eventually lead to greater participation in the bull market.”

It’s interesting that overall sentiment — both toward the market and the economy — remains sour despite gains of nearly 18% on the S&P 500 this year. Many investors have been frustrated by the continued narrowness of the market as well as by the increased volatility in economic data. Specifically, U.S. activity data has been slowing with a decrease in positive surprises, but the labor market has largely held up and consumer spending hasn’t rapidly deteriorated. There have been anomalies in jobs data, notably the unusually large divergence between the payroll report’s surveys of employers and households, which has raised doubts about the true strength of hiring.

“That said, I don’t think we’ll see any labor market cracks open into fissures in the near future,” Orton said. In the past, he noted, the corporate sector has only started to fire employees once profitability has come under sustained pressure. “That simply isn’t happening right now.”

In fact, the resilience of profit margins has been one of the most surprising features of the U.S. economy over the last 18 months. Profit margins continue to be revised higher, not lower, and that gives Orton confidence that we’re not likely to see a rapid deterioration in the labor market, which in turn supports the consumer.

Second-quarter results are expected to build on the rebound of the past two quarters. For Q2 2024, the estimated year-over-year earnings growth rate for the S&P 500 is 8.8%, and Orton said it’s worth noting that the typical decline we tend to observe in analyst estimates throughout the quarter didn’t occur in the second quarter. Rather, the decline in the bottom-up earnings per share estimate recorded during the second quarter was smaller than the 5-, 10-, 15-, and 20-year averages. Earnings growth is also expected to be broad across the index, with four sectors predicted to report double-digit growth: communication services, healthcare, information technology, and energy. Healthcare and energy were both double-digit decliners last quarter, so the inflection in earnings growth we’ve observed this year looks set to continue in the second quarter, which Orton said can provide further support to the market. Critically, the estimated net profit margin for the S&P 500 for the second quarter stands at 12.0%, which is:

  • above the previous quarter’s net profit margin of 11.8%,

  • above the year-ago net profit margin of 11.6%, and

  • above the 5-year average of 11.5%.


Seasonality is on our side: The first half of July is historically the strongest stretch
Average & median S&P 500 returns by first/second half of month (1928–2023)
Average & median S&P 500 returns by first/second half of month (1928–2023)

Source: Bloomberg; as of 7/5/24.

Three themes to consider

This week brings the Consumer Price Index (CPI), Producer Price Index (PPI), and University of Michigan Index of Consumer Sentiment, as well as the start of earnings season.

This also is the strongest seasonal period for the market: Since 1928, the first 10 trading days of July have historically been the strongest period for the S&P 500 Index, with the benchmark advancing 1.5% on average and rising nearly 70% of the time. Orton said this should provide some support should data continue to point toward a gradually cooling inflationary backdrop.

Then there’s small caps, which continue to underperform and which last week hit a 10-to-1 ratio of lows to highs. Surely, Orton said, with yields down and economic growth not showing signs of deterioration, smaller companies ought to be able to catch a bid and move up. On the international front, we have resolution on the elections in Europe, which he said should allow some of the beaten-down names to emerge from their hangovers and start to trade on fundamentals once again. Key parts of the market that Orton is following include:

  • Momentum and quality. The continued strength of momentum is on display with the mega-caps still dominating the market. But Orton said there are reasons these companies are doing well, and that’s because earnings are visible, growing, and have clear catalysts in the dominant secular growth driver of artificial intelligence (AI). “It’s easy to dismiss the AI theme as being stretched in the short term or valuations as being expensive, but the market disagrees, and earnings growth has disagreed as well,” he said. There are also ways to keep up and even outperform the market by leaning into the capital expenditures beneficiaries of the AI buildout, or by leaning into critical growth trends. Pharmaceuticals and certain consumer products have benefitted from the rapid rise of glucagon-like peptide 1 agonists (GLP-1) weight loss drugs, while budget big-box retailers have been top performers this year as consumers find ways to cope with inflation. Orton said now is a time to consider having an overweight exposure to these areas since earnings should help to keep these names pushing higher. And once we get into earnings season, he hopes we’ll continue to see strong results from larger banks and the industrials complex to bring some breadth back to the market.

  • International markets. It’s encouraging to see European markets continue to rebound now that we’re through elections in the U.K. and France. In the U.K., the Labor Party’s landslide victory gives the party a clear mandate to govern and likely signals a sustained period of political stability. In France, while there might not be a lot of visibility at this point, the worst-case scenarios of an absolute majority for either the right-wing National Rally or the left-wing New Popular Front have been avoided, which brings a bit of relief to investors even if the main scenario of gridlock isn’t too bullish either. As we head into earnings season, Orton thinks some of the financial and industrial companies that sold off on the expectation of a National Rally majority have scope to further recover, especially with earnings likely to be supported by a better than feared economic backdrop. In Japan, solid wage growth data provides the Bank of Japan more confidence that the wage-price cycle is starting to spin, giving policymakers additional scope to hike rates at the July meeting, which should benefit Japanese financials. Stocks in Australia, Taiwan, and South Korea also show signs of strength. Overall, Orton said, there are a lot of positives overseas, allowing investors to consider looking abroad as a way to diversify portfolios and to lean into different drivers of strength outside the United States.

  • What is happening to small caps? Small-cap underperformance relative to large-caps continued last week even as interest rates moved lower and economic data continued to highlight that there doesn’t seem to be any rapid deterioration in growth. Outflows continued for the space as investor interest is nonexistent, despite historic underperformance and relative valuation discounts. The Russell 2000® Index is now underperforming the S&P 500 by nearly 17% year to date and over 30% since the start of 2023.

    “While I think the market is over-reacting to the slowing growth story — and I continue to believe that the data is signaling that growth is simply normalizing to trend levels — this is a tough space right now,” Orton said. Small-cap growth has started to show some signs of life and biotechnology has been recovering nicely from its April lows as we see more deal activity. He’s encouraged that sector performance down the market cap spectrum is not indicative of recessionary positioning and noted that mid-caps are performing in line with the S&P 500® Equal Weight Index. Still, he said, it’s ultimately going to take positive earnings surprises and upward revisions to get any positive attention on the space.

    “I tend to think the risk-reward down market cap still looks interesting, especially if the narrative settles on a soft landing and some increased clarity on the inflation front,” Orton said. For investors looking for diversification opportunities, he favors considering a small exposure that can increase if and when we get clarity in earnings season.

What to watch

It will be a busy week as investors scour economic data and the start of the second-quarter earnings season. Fed Chair Jerome Powell will deliver his biannual testimony on Capitol Hill on Tuesday ahead of the Fed’s next interest rate decision on July 31. The CPI report is issued on Thursday, and Friday brings the University of Michigan consumer sentiment survey results, which notably will include long-term inflation expectations.


% of S&P 500 sector by market cap reporting earnings per week
% of S&P 500 sector by market cap reporting earnings per week

Source: Bloomberg; as of 7/5/24.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of July 5, 2024.

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
Bottom-up investing focuses on evaluating the fundamentals of a specific company or group of securities, such as revenue or earnings, as opposed to looking at macroeconomic trends or cycles in markets.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.

Catch a bid is a phrase used in finance to describe a security or group of securities with prices that have moved up significantly.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

GLP-1 weight-loss drugs, formally known as glucagon-like peptide 1 agonists, comprise a class of type 2 diabetes drugs that improve blood sugar control and may also lead to weight loss. The drugs mimic the action of a hormone called glucagon-like peptide 1 by stimulating the body to produce more insulin when blood sugar levels start to rise after someone eats. The additional insulin helps lower blood sugar levels, which helps in controlling type 2 diabetes. How GLP-1 agonists lead to weight loss is less clear.

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. At that time, they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.

A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.

Overweight describes a portfolio position in an industry sector or some other category that is greater than the corresponding weight level in a benchmark portfolio.

The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of both households and employers.

The Producer Price Index (PPI), published monthly by the U.S. Bureau of Labor Statistics, measures the average change over time in the selling prices received by domestic producers for their output.

Quality investing is a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance, as reflected in financial metrics such as ratios of return to equity and debt to equity, as well as to earnings variability.

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.

The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.

Visibility reflects the degree to which a company’s management, the analysts who follow particular stocks, or market participants more generally can reliably estimate the future near- or long-term performance of a security, industry, sector, index, or asset class.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.

The Nikkei 225 Index is a price-weighted equity index that consists of 225 stocks in the first section of the Tokyo Stock Exchange, excluding exchange-traded funds, real estate investment trusts, and preferred equity contribution securities.

The MSCI Emerging Markets Index captures large and mid-cap representation across emerging markets countries that include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

 

M-569505 Exp. 11/8/2024


July 1, 2024: Earnings breadth not yet reflected in performance

Key points

  • Being selective in equities is critically important with dispersion at incredible levels.

  • Watch this week’s jobs data, especially the non-farm payrolls report on Friday.

  • Think about “AI 2.0” That’s not only artificial intelligence itself, but everything that the growth of AI both contributes to and benefits from (semiconductor manufacturing, electrical generation, and more).

 


 

Will the second half of 2024 be as surprising as the first?

Many investors came into the year optimistic, but the strength of the rally and continued concentration of equity performance defied expectations. The S&P 500 Index closed the first half of the year with a whopping 14.5% advance, largely driven by a blistering rally in technology stocks and other companies tied to artificial intelligence (AI).1 The increase in breadth that many expected has trailed off over the past few months. And don’t forget that 2024 began with markets implying more than six interest rate cuts and a continued rally in U.S. Treasury bonds, but neither of those scenarios materialized. Consequently, many investors now question what’s next, particularly with the S&P 500 sitting around all-time highs.

Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, remains optimistic moving forward. He believes that increasing earnings breadth should translate into increased breadth in price performance.

“With dispersion incredibly high, selectivity will be critical, and investors shouldn’t chase the market higher,” Orton said. Rather, he said now is a time to consider using any consolidation to add exposure or to reset asset allocations. “I continue to advocate for leaning into the quality momentum winners over the past 18 months and opportunistically broadening portfolios with any pullbacks in the big banks, select industrials, software, and international exposure.”

On the economic front, Orton said we’re getting more constructive data points on inflation while the economy continues to hold up, slowing to a more normalized growth environment. Personal Consumption Expenditures (PCE) Price Index inflation for May came in last week on the soft side, with core inflation rising 0.083% month over month.


What a run...
S&P 500 industry returns vs. earnings revisions
S&P 500 industry returns vs. earnings revisions

Source: Bloomberg; as of 6/28/24.

While it was an unambiguously good report, Orton said it’s worth noting that PCE inflation for April had a very slight upward revision from 0.249% to 0.259%. Even as it may lead dovish U.S. Federal Reserve (Fed) officials to become more assertive, Orton doesn’t expect this to change the requirement of most Federal Open Market Committee participants to see more of these “good” inflation reports. Consequently, he continues to see December as the most likely timing of the first rate cut.

Investors also got some positive data on personal income, which jumped by 0.5% with wages and salaries rising at a more robust 0.7%: an indication that consumers will continue to support economic growth in coming months. However, services spending slowed meaningfully in May and Orton said we need to watch this closely over the summer to see if the recent slowdown is more than just a blip.

On the international front, Orton said investors might be tempted to play the election risk in France and/or the U.K., but he would caution against it. In France, the far-right Rassemblement National won strong support in the first round of the French parliamentary elections as expected, but its chances of securing an absolute majority look somewhat diminished in light of some opinion polls in recent days. However, the first round produced an unprecedented number of three-way runoffs, and this injects additional uncertainty into the outcome.

“I would wait until we get closer to the final July 7 election to think about bottom-fishing for quality assets,” he said. He added, however, that this doesn’t mean that other developed or emerging markets aren’t quite attractive in the second half of 2024. Orton said it’s worth noting that Japanese stocks outperformed the Nasdaq Composite Index in the first half of 2024 with the Nikkei 225 Index up 18.28% (in local currency) versus the 18.13% gain in the Nasdaq. There are reasons to be optimistic going forward, Orton said, noting that Japan is the largest country weight in the MSCI EAFE® (Net) Index. The MSCI India Index outperformed the S&P 500 in the first half of the year with a 16.67% gain and looks to Orton to be poised to continue its upward momentum.

“This all highlights why selectivity is so important and why now is a time to consider looking for opportunities to build balance in portfolios,” he said.

Key themes going forward

A new quarter and a new half year often leads to new money coming into equities, Orton said. In addition, he said share prices could benefit from strong seasonal trends and rising engagement from retail investors. Since 1928, the first 15 days of July have been the best two-week trading periods of the year for the S&P 500, and they tend to fade after July 17. That said, there’s a lot of economic data reports this week that Orton said could keep the market from gaining too much momentum. Friday’s jobs report, officially known as the Employment Situation Summary, will be particularly important. A report that is too hot will likely lead investors to question whether that data is consistent with the Fed’s definition of labor market “rebalancing,” while a report that is too cold will increase questions about the state of the economy and whether the recent slowing will lead to a more meaningful deterioration. Also, pay attention to the Job Openings and Labor Turnover Survey (JOLTS) report, because a decline in the job openings rate from the current 4.8% to 4.5% would send a warning sign of more rapidly rising unemployment.

“The jobs report on Friday will be critical, and I would tread carefully in the market until after that,” he said. Adding to the short-term “wait and see” approach is increasing bond volatility and the recent rise in high-yield credit spreads; Orton said a continued or more material widening poses a risk for equities. Uncertainty overseas has also supported the U.S. dollar, adding to some of the elevated macroeconomic uncertainty that investors face.

Orton’s key themes focus on why he believes it makes sense to stick with the momentum winners and to look for underappreciated AI plays in what he calls “AI 2.0.” This theme looks beyond AI itself to the sectors and industries that are poised to benefit from the additional hardware, software development, and electrical generation that the growth of AI requires, as well as to companies and industries positioned to turn AI’s transformational capabilities to their advantage.

Orton’s investment playbook


Orton’s investment playbook

What to watch

It might be a holiday-shortened week, but there is still plenty to look forward to on the calendar. The jobs report on Friday will dominate the economic calendar, where economists expect payroll gains to slow from 272,000 in May to 200,000 in June with the unemployment remaining at 4.0%. We also get JOLTS on Tuesday and the ADP® National Employment Report on private sector employment on Wednesday. Across the pond we get inflation readings for Europe, where core inflation in the Eurozone Harmonised Index of Consumer Prices is expected to fall in June. An additional focus will be on this week’s European Central Bank’s annual forum on central banking.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of June 28, 2024.

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
The ADP® National Employment Report is published monthly by the ADP Research Institute® in close collaboration with Moody’s Analytics. The ADP® National Employment Report™ provides a monthly snapshot of U.S. nonfarm private sector Employment based on actual transactional payroll data.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.

Core inflation measures generally exclude prices that are considered to be more volatile and thus less useful for tracking longer-term trends in inflation, including prices for food and, in many instances, fuel.

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.

Developed markets countries include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the U.K., and the United States.

Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.

Dividend payers are the companies that distribute a portion of their profits to shareholders in the form of a dividend.

Dovish, hawkish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Centrists tend to occupy the middle of the continuum between tight (hawkish) and loose (dovish) monetary policy.

Emerging markets include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates.

The Eurozone Harmonised Index of Consumer Prices is a composite measure of inflation in the Eurozone based on changes in prices paid by consumers in the European Union for items in a basket of common goods. The index tracks the prices of goods such as coffee, tobacco, meat, fruit, household appliances, cars, pharmaceuticals, electricity, clothing, and many other widely used products.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.

Personal consumption expenditures (PCE) measure consumer spending for a period of time. PCEs are one measure that is reported by the Bureau of Economic Analysis.

The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, is known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.

High-yield bonds have credit ratings below BBB- from Standard & Poor’s or below Baa3 from Moody’s.

The Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics. The survey’s job openings rates consider month-to-month changes in the number of job openings reported on both a state and national level.

The jobs report, also known as the payroll report and officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.

Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

Rebalancing in the labor market is a term used by U.S. Federal Reserve officials to describe the process of moving toward an optimal relationship in the economy between healthy levels of employment and inflation.

Reshoring describes the effort to bring manufacturing and other services back to the United States from overseas operations.

Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to US citizens but not applicable to citizens in the overseas country.

The MSCI India Index is designed to measure the performance of the large- and mid-cap segments of the Indian stock market. With 136 constituents, the index covers approximately 85% of the Indian equity universe.

The Nasdaq Composite Index is the market capitalization-weighted index of more than 2,500 common equities listed on the Nasdaq stock exchange.

The Nikkei 225 Index is a price-weighted equity index that consists of 225 stocks in the first section of the Tokyo Stock Exchange, excluding exchange-traded funds, real estate investment trusts, and preferred equity contribution securities.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

 

M-567542 Exp. 11/1/2024