Markets in Focus

Timely analysis of market moves and sectors of opportunity

Jan. 30, 2023: The market can’t have it both ways

This could be the most consequential week of the first quarter, with 20% of the S&P 500 reporting earnings, plus key inflation and labor market reports coming out. And, critically, the U.S. Federal Reserve (Fed) is expected to raise interest rates again even as markets bank on the idea of interest rate cuts in the near future.

“I believe the market is too enthusiastic around expectations that the Fed will cut rates in the second half of the year and that we navigate perfectly a soft landing,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “I certainly think that the economy’s in better shape than it had been given credit for last year, but I don’t believe the immaculate deflation narrative or that a perfect soft landing will be as easy to pull off as a lot of people think. There is going to have to be some sort of economic pain to get out of a recessionary scenario, because if there isn’t the Fed’s not going to cut rates. You can’t have it both ways. So I would expect the Fed to push back against the market rally.”

Last week was another good week for the market, but it was a great one for the longer duration and more speculative assets that continue to reverse their challenging performance from last year. The Nasdaq Composite Index notched its fourth positive week in a row, up 4.7%, bringing its year-to-date return to 11.2%: close to double the 6.7% gains of the S&P 500 Index. Orton said it’s worth noting that there has been a nearly complete reversal of the factors that dominated last year, with momentum, profitability, and dividends all struggling while volatility, leverage, short interest, and earnings variability are all leading.

Quote
There is going to have to be some sort of economic pain to get out of a recessionary scenario, because if there isn’t the Fed’s not going to cut rates.


“I can understand some of the enthusiasm supporting the market reversal, primarily the notion that the economy is in better shape than many investors feared and that a hard landing isn’t a foregone conclusion,” he said. However, the character of the gains and the low-quality rally taking place also reflects a market convinced that the rate-hiking cycle is coming to a close. And that is a real risk heading into this week when Fed Chairman Jerome Powell might push back against the market’s refusal to price fully price in the consistent policy guidance provided at the Fed’s December policy meeting and by numerous speakers since.

One of the challenges right now is that economic data and earnings results can be used to support two very different outcomes, Orton said. Hard data has continued to hold up well: U.S. gross domestic product (GDP) growth was stronger than expected last week with a quarter-over-quarter rise of 2.9% while initial jobless claims are near cycle lows. However, under the surface the GDP rise masked sharp deterioration in consumer and business demand at the end of 2022. Inventory accumulation was the biggest contributor to fourthquarter growth, along with plunging imports (led by durable goods), suggesting the build is unwanted. Further, soft data also paints a mixed picture. The Institute for Supply Management’s Purchasing Managers’ Index for manufacturing and Services ISM® Report on Business® are rolling over; and the Conference Board Leading Economic Index® is pointing to a sharp slowdown in the economy. Which side of the coin should we believe? On the earnings front, results have been worse than expected and margins continue to move lower, but guidance has generally held up and Orton said he would say that the results have been good enough. The market agrees and has been rewarding both earnings beats and misses more than usual. Interestingly, information technology and communication services have been the top detractors from S&P 500 earnings and revenue growth — yet both sectors have staged a very strong recovery. Being able to hold up in the face of bad news is generally positive, but Orton said he worries that the technicals are in control rather than the fundamentals. Healthcare and energy have actually been reporting earnings-per-share (EPS) and revenue surprises, but both sectors have struggled amid the momentum reversal.

Given the macroeconomic uncertainty that still exists coupled with a market that continues to fight the Fed, Orton said he can’t help but remain cautious in the near term. Financial conditions have eased considerably over the past few months and the labor market remains tight. While the Fed seems all but certain to downshift again with a 25-basis point (bp) interest rate increase, that doesn’t mean it’s done. Powell has reiterated that rates will remain higher for longer, and there is no reason to think we won’t get to at least 5% for the terminal rate.

We’ll have more clarity on Wednesday, Orton said, but if there is a hawkish tone, this will likely cause a sharp reaction in the market as the growth trade, which is predicated on rate cuts, and a perfect soft landing partially unwinds.

Momentum generally is the safety or low-beta trade during bear markets, Orton said. Once credit conditions peak, implied volatility starts to fall and the market begins to bottom – and momentum starts to unwind or crash. Losers become winners and are often the names most associated with high short interest and poor fundamentals. Momentum is unwinding, accompanied by easing credit conditions, he said. The question is whether this is warranted given the ultimate destination for the Fed’s monetary policy and potentially slower growth than currently priced by the market.

Across the market, non-earners and the most expensive names have been outperforming. Generally, this is how new bull markets are born, Orton said. But that’s usually because the prospects for these companies are starting to turn as revenue and earnings growth estimates are revised higher. Right now, Orton said he worries that many of these industries/sectors are still undergoing downward revisions. That’s not the say there aren’t some great opportunities. We just need to be very selective and not chase the broad market higher, he said.

Small caps remain attractive

Small and mid caps have been outperforming large year to date, and Orton said he continues to favor leaning into small caps for 2023. Valuations remain attractive both relative to large caps and on an absolute basis. Earnings forecasts have stabilized and levels meaningfully above large, and he said he would expect the weaker dollar and better credit conditions to provide additional support. The technical set-up is also quite attractive, he said, and we haven’t seen flows pick up into the space.

Quality has continued to outperform despite some shifts beneath the surface

Source: Bloomberg, as of 1/30/2023

Quote
If there is a hawkish tone, this will likely cause a sharp reaction in the market as the growth trade, which is predicated on rate cuts, and a perfect soft landing partially unwinds.


What to watch

This busy week includes interest rate decisions from the Fed, European Central Bank, and Bank of England as well as a key Organization of the Petroleum Exporting Countries gathering and a flurry of heavyweight earnings. The macroeconomic calendar includes the unemployment report, which is expected to show a rise in nonfarm payrolls of 225,000, as well as the U.S. Consumer Confidence Survey® and the ISM manufacturing Purchasing Managers’ Index.

This week's data releases

Monday Germany GDP; Spain Harmonised Index of Consumer Prices (HICP) inflation; Brazil primary budget balance
Tuesday U.S. Consumer Confidence Survey; France, Italy, Mexico, and Eurozone GDP; France and Germany HICP inflation
Wednesday U.S. Federal Open Market Committee interest rate decision, light-vehicle sales, construction spending, and ISM manufacturing PMI; Eurozone Harmonised Index of Consumer Prices; Italy HICP inflation; Brazil rate decision, trade; South Korea industrial output
Thursday European Central Bank interest rate decision; U.K. Bank of England interest rate decision; U.S. initial jobless claims, durable goods, and factory orders; Spain unemployment; South Korea Consumer Price Index
Friday U.S. unemployment and nonfarm payrolls; Caixin China General Services Purchasing Managers Index; Eurozone Services Purchasing managers; Index and industrial producer price Index

 

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 Carillon Tower Advisers 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.

Deflation is a general decline in prices for goods and services in an economy. It is typically associated with a contraction in the supply of money and credit.

Equity duration is the cash-flow weighted average time at which investors can expect to receive the cash flows from their investment in a company’s stock. Long-duration stocks include fast-growing technology companies, including those that may not pay any dividends in their early years, while short-duration stocks tend to be more mature companies with higher ratios to dividend to price.

Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.

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.

Profit factor investing considers the gross profit of an investment divided by the gross loss (including commissions) for the entire trading period. This method is used to assess the amount of profit per unit of risk, with values greater than one indicating a profitable system.

Dividend investing is a strategy that seeks to invest in companies that pay out dividends and considers a company’s dividend yield, ability to grow and pay dividends over time, and dividend payout ratio, or the amount being paid out to shareholders in the form of dividends versus how much income the company retains.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

Short interest is the number of shares that have been sold short and remain outstanding. Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price. Short interest often is seen as an indicator of current market sentiment. Rising short interest signals that investors have become more bearish. Falling short interest signals that they have become more bullish.

Earnings variability is a factor, along with other financial metrics such as ratios of return to equity and debt to equity, that plays a key role in quality investing, a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

The Conference Board Leading Economic Index® for the United States is designed to signal peaks and troughs in the business cycle, to be highly correlated with real (adjusted for inflation) GDP, and to be a predictive variable that anticipates (or “leads”) turning points in the business cycle by around seven months. It is comprised from 10 components: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; Institute for Supply Management® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Index; Leading Credit Index™; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

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.

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%.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

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

Beta is a measure of the volatility or systemic risk of a security or portfolio compared with the market as a whole.

Implied volatility is a measure of volatility levels based on the market’s assessment of likely future volatility. It is thus different from realized volatility, also known as historical volatility, which measures levels of volatility that took place in the past.

The daily moving average (DMA) is a calculation that takes the arithmetic mean of a given set of prices over the specific number of days in the past; for example, over the previous 15, 30, 100, or 200 days.

Harmonised Index of Consumer Prices (HICP) inflation readings are compiled and released by the European Union’s Eurostat office for individual European Union member states including Spain, France, Germany, and Italy.

The U.S. Consumer Confidence Survey®, published monthly by The Conference Board, reflects prevailing business conditions and likely developments for coming months based on consumer attitudes, buying intentions, vacation plans, and expectations for inflation, stock prices, and interest rates.

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 South Korea Consumer Price Index, compiled monthly by Statistics Korea, measures the average change in prices for a fixed-market basket of goods and services of constant quantity and quality purchased by consumers.

The Caixin China General Services PMI, compiled by IHS Markit, tracks sales, employment, inventories, and prices in China’s services industry. It is based on data compiled from monthly replies to questionnaires sent to purchasing executives in more than 400 companies. Survey responses reflect the change, if any, in the current month compared to the previous month based on data collected mid-month. A reading above 50 indicates expansion, while anything below that points to contraction.

The Eurozone Services PMI (Purchasing Managers’ Index) is produced by IHS Markit and is based on original survey data collected from a representative panel of around 2,000 private sector service firms. National data are included for Germany, France, Italy, Spain, and the Republic of Ireland. These countries together account for an estimated 78% of Eurozone private sector services output.

The Eurozone industrial producer price index (PPI) tracks transaction prices for the monthly industrial output of various economic activities in the European Union. The index measures price changes from the seller’s perspective and serves as an early indicator of inflationary pressures in the economy and records the evolution of prices over longer periods of time.

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 75% of the investable U.S. equity market.

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

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 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark 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.

 

RJIM23-0060 Exp. 5/30/2023


Jan. 23, 2023: Every silver lining has a cloud

The “everything rally” tried to claw its way back on Friday with technology shares leading the way higher following some strong earnings results and more announced layoffs, but this remains a time to be patient and cautious, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“There are places to be in the market that continue to do well, and I want to hang out there and wait for the dust to settle a little,” he said. “There’s no need to be aggressive with as many question marks as remain for this market. The best thing to do is to question what is really driving the current rally while remaining more defensive. There are reasons to be optimistic, but now’s not the time to be flipping that switch.”

Last week’s strong gains stand in contrast to what Orton said he believes was a clear message from a string of U.S. Federal Reserve (Fed) speakers. The general picture they painted is of a Fed that may be slowing rates — several mentioned the possibility of considering 25-basis point (bp) increments at coming meetings — but a Fed that still sees rates heading above 5% nonetheless. Fed funds futures and overnight index swaps continue to price a terminal rate below that, raising the possibility that both stocks and bonds may need to make a swift readjustment after the Federal Open Market Committee (FOMC) meeting on Feb 1. Financial conditions have eased significantly since the market lows in October with some measures such as the Bloomberg U.S. Financial Conditions Index back to levels last seen in February. As a result, both risk assets and safe havens have rallied at the start of 2023. It’s already the best year for U.S. investment-grade credit since daily data began in 1999, and it’s also the best start to the year for U.S. Treasuries since daily Bloomberg data began in 1995. Orton said he can’t help but expect that Fed Chairman Jerome Powell will push back against these developments next week.

While there’s certainly reasons for optimism, Orton said he believes that the market has shifted too quickly to pricing in a Goldilocks narrative where the Fed stops tightening and we navigate a soft landing. The biggest challenge he said he sees is how the market resolves its disconnect with the Fed. Inflation is currently priced by the market to fall to 2.2% year over year by June and to remain around 2.0% to 2.6% for the balance of the year, with 50 bps of rate cuts priced from June to December and then moving back to near neutral in 2024.

Yet the Fed has continued to indicate that rates will move above 5% and remain there for the duration of 2023. That’s a big difference, and Orton said his worry is that risks are skewed to the downside in the near term after hearing so many members of the FOMC repeat the refrain of higher for longer. While some of the soft data, including the Institute for Supply Management’s manufacturing Purchasing Managers’ Index and Services ISM® Report on Business®, point to recession, corporate and household balance sheets are in good shape while unemployment remains low at 3.5%.

Quote
Data has proved more resilient than expected while inflation continues to move lower. But something has to give.


“It would take a lot of pain to come very quickly for the Fed to start cutting rates like the market is predicting in the second half of 2023,” Orton said. “We’re currently operating in an unstable equilibrium where data has proved more resilient than expected while inflation continues to move lower. But something has to give. If data continues to hold up and the labor market remains tight, then inflation will not fall to levels acceptable to the Fed without policy being restrictive for longer.”

Overall, Orton said he continues to believe we should not be chasing this everything rally. Both equities and fixed income markets are overbought and overly optimistic. While he said he is encouraged to see the market pricing in a higher likelihood of a softer landing, the market narrative has gotten ahead of itself and needs to have some resolution. Remaining more defensively positioned by leaning into quality has continued to work into 2023, Orton said, and he believes this will be the case going forward as we move through earnings season. There has been a quiet shift beneath the surface where momentum has started to break down with defensive sectors being challenged while nearly everything else has jumped. Within this shift, growth has started to bottom but at the same time investors remain focused on valuations, which he said is why growth at a reasonable price (GARP) has outperformed. U.S. small caps have also outperformed year to date and Orton said he still believes this part of the market looks attractive. Selectivity matters, he said, so accordingly he favors higher-quality, actively managed small caps. Global markets have also continued their march higher and Orton said he still prefers emerging markets to get exposure, particularly Asian markets that are tied to the China reopening theme. International developed-market equities have found strength from Europe, notably the banks that should benefit from the pivot away for negative interest rates, but the MSCI EAFE® (Net) Index is highly overbought and overdue for a correction, he said. If we do have a pullback on a Fed reset, Orton said he also believes investors can start to find value in some of the higher-quality growth names that were thrown out with the bathwater, particularly software companies that have a path to profitability and strong secular tailwinds.

Quality has continued to outperform
despite some shifts beneath the surface


Quality has continued to outperform despite some shifts beneath the surface

Source: Bloomberg, as of 1/20/2023

Mixed signals between deteriorating economic activity and the labor market

Economic data continues to highlight a significant dichotomy between deteriorating activity and labor market resiliency. Last week, another regional manufacturing survey, the Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey, showed a contraction in manufacturing activity that was more moderate than the plunge in the Federal Reserve Bank of New York’s Empire State Manufacturing Survey but still indicative of a downward trend. Deterioration in manufacturing remains in stark contrast to initial jobless claims ticking down yet again, as they fell to a miniscule 190,000 in the weekly payrolls survey. Though jobless claims are volatile this time a year, the current level is consistent with employers being reluctant to lay off workers and a very tight labor market. Orton said the data supports his view that we’ll see continued Fed tightening to 5%+, though we do have some additional information this week that will be important.

After last week’s retail sales report that showed a broad-based slowdown in goods spending, this week the focus will be on services spending — the largest part of the economy — in the personal income and spending report. While retail sales are largely comprised of goods spending, the one services-oriented line item in the report, restaurant spending, fell for the second consecutive month, potentially portending broader weakness in services.

Earnings season is a mixed bag so far

The actual earnings results reported so far haven’t been spectacular, lagging already lowered expectations. For the fourth quarter of 2022, the blended earnings decline for the S&P 500 Index is -4.6% (versus the consensus estimate of -3.2% as of Dec. 31, 2022) with the number and magnitude of positive earnings surprises below their 5-year and 10-year averages. However, the negative earnings surprises and downward revisions to earnings estimates have largely been concentrated in the financials sector and the outlooks have been decent overall, Orton said. As we get into information technology and consumer discretionary earnings, we’ll have a much better sense for whether guidance holds up or if there is more pain to come for these sectors that have already been beaten up. He said it’s also important to follow closely net profit margins, which continue to come down. This is expected, he said, but any commentary on whether the downward trend accelerates or if margins can hold up will be very important.

What to watch

Earnings season kicks into high gear this week with some critical reports from consumer-exposed companies as well as mega-cap technology. Fed speakers will be in a blackout period ahead of the February FOMC meeting, but we still have some important economic reports. Orton said updates on the S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index, new home sales, and durable goods orders could reinforce economic concerns and further solidify expectations for a 25-bp hike from the Fed.

This week's data releases

Monday U.S. Conference Board Leading Economic Index®; Eurozone Consumer Confidence Indicator
Tuesday U.S. Federal Reserve Bank of Richmond manufacturing Index; au Jibun Bank Japan Manufacturing PMI®
Wednesday U.S. Mortgage Bankers Association Weekly Applications and Federal Reserve Bank of Philadelphia Nonmanufacturing Business Outlook Survey; Canada interest rate decision; Germany ifo Institute Business Climate Index; Australia consumer price index; Japan Leading Economic Index; Mexico economic activity
Thursday U.S. fourth-quarter gross domestic product, initial jobless claims, new home sales, durable goods, and wholesale and retail inventories; Mexico unemployment; South Korea gross domestic product; Interest rate decisions from South Africa and Chile
Friday U.S. personal income and spending, pending home sales, and University of Michigan Index of Consumer Sentiment; Spain gross domestic product; Japan Tokyo Consumer Price Index; Australia Producer Price Indexes; Colombia interest rate decision

 

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 Carillon Tower Advisers 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.

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%.

The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

A futures contract is a legal agreement to buy or sell an asset at a predetermined price at a specified time in the future, which is known as the expiration date. Futures contracts are financial derivatives that allow investors to speculate on the direction of a particular asset and are often used to hedge the price movement of the underlying asset to help prevent losses from undesired price changes.

An overnight index swap is a hedging contract in which a party exchanges a specific cash flow with a counter-party on a specified date and uses an overnight rate index such as the federal funds rate as the agreed-upon exchange for one side of the swap.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation.

The Bloomberg U.S. Financial Conditions Index measures the relative strength of the U.S. money markets, bond markets, and equity markets in an effort to assess overall conditions in U.S. financial and credit markets. The values of the Bloomberg index are calculated as Z-scores, which measure the number of standard deviations that daily financial conditions are above or below the average of financial conditions during the January 1994 through June 2008 period.

Investment-grade refers to fixed-income securities rated BBB or better by Standard & Poor’s or Baa or better by Moody’s.

The neutral rate is the theoretical federal funds rate at which the stance of U.S. Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

Overbought is a term used to describe a security believed to be trading at a level above its intrinsic or fair value.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

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.

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

Growth at a reasonable price (GARP) is a stock investment strategy that seeks to combine tenets of both growth and value investing in the evaluation and selection of individual stocks. GARP investors look for companies with consistent earnings growth above broad market levels but try to avoid companies with very high valuations. By trying to avoid the extremes of either growth or value investing, GARP investors often end up focusing on growth-oriented stocks with relatively low price-to-earnings multiples in normal market conditions.

Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.

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.

Dividend investing is a strategy that seeks to invest in companies that pay out dividends and considers a company’s dividend yield, ability to grow and pay dividends over time, and dividend payout ratio, or the amount being paid out to shareholders in the form of dividends versus how much income the company retains.

Profit factor investing considers the gross profit of an investment divided by the gross loss (including commissions) for the entire trading period. This method is used to assess the amount of profit per unit of risk, with values greater than one indicating a profitable system.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

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.

The Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey is a monthly survey in which manufacturers in the Third Federal Reserve District, which includes Pennsylvania, New Jersey, and Delaware, indicate the direction of change in overall business activity and in various measures of activity at their plants: employment, working hours, new and unfilled orders, shipments, inventories, delivery times, prices paid, and prices received.

The Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York.

Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.

A consensus estimate is a forecast of a public company’s projected earnings based on the combined estimates of all equity analysts that cover the stock.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan areas: Atlanta, Boston, Charlotte, Chicago, Cleveland, Dallas, Denver, Detroit, Las Vegas, Los Angeles, Miami, Minneapolis, New York, Phoenix, Portland, San Diego, San Francisco, Seattle, Tampa, and Washington, D.C.

The Conference Board Leading Economic Index® for the United States is designed to signal peaks and troughs in the business cycle, to be highly correlated with real (adjusted for inflation) GDP, and to be a predictive variable that anticipates (or “leads”) turning points in the business cycle by around seven months. It is comprised from 10 components: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; Institute for Supply Management® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Index; Leading Credit Index™; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.

The Eurozone Consumer Confidence Indicator is conducted by the Directorate General for Economic and Financial Affairs to measure consumer confidence within different sectors of the economies in the European Union and in the applicant countries.

The Richmond Manufacturing Index is a monthly composite index published by the Federal Reserve Bank of Richmond that represents a weighted average of the business conditions of manufacturing companies in Maryland, North and South Carolina, Virginia, most of West Virginia, and the District of Columbia. The index focuses on shipments, new orders, order backlogs, capacity utilization, supplier lead times, number of employees, average work week, wages, inventories, and capital expenditures. A rise in the index signifies improvement and growth, while a decrease in the index signifies a contraction.

The au Jibun Bank Japan Manufacturing PMI® is a purchasing managers’ index compiled by S&P Global from responses to monthly questionnaires sent to purchasing managers at about 400 manufacturers. The panel is stratified by detailed sector and company workforce size, based on contributions to Japan’s gross domestic product.

The Mortgage Bankers Association Weekly Applications covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.

The Federal Reserve Bank of Philadelphia Nonmanufacturing Business Outlook Survey is a monthly survey of non-manufacturers in the Third Federal Reserve District, , which includes Pennsylvania, New Jersey, and Delaware. Participants indicate the direction of change in overall business activity and in the various measures of activity at their firms, including new orders, sales or revenues, employment, prices, and capital expenditures. Respondents also provide their assessments of general business conditions over the next six months.

The ifo Institute Business Climate Index for Germany is based on a monthly survey of about 9,000 firms in manufacturing, the services sector, and construction, plus wholesale and retail sales about their characterization of their current business and their expectations for the next six months. It is published by the ifo Institute for Economic Research, based in Munich.

The Australian Consumer Price Index is a quarterly report from the Australian Bureau of Statistics measuring household inflation. It includes statistics about changes in price for a wide range of categories of household spending.

The Japan Leading Economic Index, released by the Cabinet Office of the national government of Japan, tracks economic indicators in more than a dozen categories, including inventories, new job offers, machinery orders, housing construction, consumer confidence, stock prices, money supply, the investment climate, operating profits in manufacturing, government bond yields, and sales forecasts for small business.

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.

The Tokyo Consumer Price Index, excluding fresh food, is released by the Statistics Bureau of Japan and tracks a range of consumer prices in the Tokyo metropolis.

Australia’s Producer Price Indexes, published by the Australian Bureau of Statistics, provide summary measures of the movements in various categories of prices over time in Australia’s mining, manufacturing, construction, and services industries.

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 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 75% of the investable U.S. equity market.

Bloomberg® and the Bloomberg U.S. Financial Conditions Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Raymond James Investment Management. Bloomberg is not affiliated with Raymond James Investment Management, and Bloomberg does not approve, endorse, review, or recommend Raymond James Investment Management’s Markets in Focus Weekly Insights. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to Raymond James Investment Management’s Markets in Focus Weekly Insights.

 

RJIM23-0042 Exp. 5/23/2023


Jan. 17, 2023: The destination matters more than the path

The stock market’s rise at the start 2023 has been a welcome change from last year, but Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, says that the continuing narrative clash between the markets and the U.S. Federal Reserve (Fed) means that it’s still prudent to be skeptical.

After one of the worst years for a 60/40 portfolio in the past century, this year has started out with almost a complete reversal of last year’s trends: a 60/40 portfolio is off to the best start in the past three decades. There is also clearly a trend of allocations leaving the United States and moving to the rest of the world with the S&P 500 Index lagging global equities and the dollar continuing to take a beating. The increased optimism has largely been driven by economic data that continues to support the peak inflation narrative and an increased possibility of a soft-ish landing for the U.S. economy. International equities also have benefitted from positive expectations around China’s reopening and a warmer than expected winter in Europe.

“That said, I believe the increased level of optimism is a bit premature, particularly given a growing disconnect between the Fed and market expectations,” Orton said. Not only are markets continuing to bet on rate cuts for 2023, they’re also betting the Fed will stop short of getting above 5% on the terminal rate, even in the absence of recession. “I certainly wouldn’t want to be on the wrong side if the out-trade between Fed rhetoric and market pricing is resolved in the favor of the Federal Open Market Committee (FOMC). Let’s remember that the December minutes highlighted that not a single committee member expected rates to fall in 2023, which should be a clear warning about getting too optimistic too soon.”

The big economic data release last week was the Consumer Price Index (CPI), which further confirmed the downward trajectory of inflation with core CPI printing 0.3% month over month, compared to 0.2% in the prior month, and headline inflation coming in at -0.1%, compared to 0.1% in the prior month. Beneath the surface, however, Orton said there were some details that were less encouraging: rent and shelter costs continued to run hot; the deceleration in the prices of goods was less encouraging outside of vehicles; and core services inflation excluding shelter — the subcomponent most reflective of the wage-price feedback mechanism — also looked sticky. While these details don’t stand out as particularly market-friendly, prices of goods overall continued to fall and the initial Fed reaction — from Federal Reserve Bank of Philadelphia President Patrick Harker, a 2023 voting member of the FOMC — validated the market expectation that the quantum of tightening is likely to shift to 25-basis point increments.

“But it’s not the path of rate hikes that ultimately matters, it’s the destination, which the Fed has told us again and again is 5% or higher,” Orton said. “The labor market remains pretty tight, and while wage growth has finally started to moderate, I don’t think it’s enough to change the terminal rate. Overall, I don’t believe the data we’ve received justifies the meaningful change in sentiment that I observed last week, though on the margin it gives me more confidence in my more optimistic outlook for the U.S. economy and corporate earnings. We’re not out of the woods, there likely will continue to be a tug-of-war between the market and the Fed, and every attempt the market made last year to call the Fed’s bluff last year didn’t end well.”

Quote
The labor market remains pretty tight, and while wage growth has finally started to moderate, I don’t think it’s enough to change the terminal rate.


Consequently, Orton said he continues to favor remaining defensive and not chasing the market higher. Leaning into dividend growth and growth at a reasonable price (GARP) have held up well even as more expensive, lower quality names have led the market higher, he said. Fixed income also plays a role in being defensive, especially as we’re closer to peak rates and the end of the hiking cycle. Yields on investment-grade and higher quality high-yield are attractive, he said, and it makes sense to be in safer senior parts of the capital structure that offer near-equity-like returns. To reach for more risk, Orton said he still likes U.S. small caps and emerging markets. Selectivity matters, he said, and he prefers higher-quality, actively managed small caps. If we do have a pullback on a Fed reset, he said he expects investors could start to find value in some of the higher-quality growth names that were thrown out with the bathwater, particularly software companies that have a path to profitability and strong secular tailwinds.

Small caps lead the way higher along with international
Year-to-date performance across select indices

Small caps lead the way higher along with international Year-to-date performance across select indices

Source: Bloomberg, as of 1/13/2023

Last week was a reminder that risks are skewed to the right-tail, Orton said. It might not be time to jump all-in on equities now, but at some point there is a massive cash stockpile that will get redeployed back into the market. Sentiment and positioning are also powerful forces. For long-term investors, Orton also emphasized that it’s not the path, but the destination that matters. Risk-reward looks more attractive now than it has in a while, especially for a properly balanced portfolio, he said. While near-term volatility is very likely, he said portfolio construction is what matters and those that focus on asset allocation and stay invested could be rewarded in the end.

Earnings season started off positively with financials

Earnings will a key driver of markets over the next few weeks heading into the FOMC meeting on Feb 1. Analysts actually took down estimates for the fourth quarter of 2022 meaningfully heading into the end of the year, and the consensus as of Dec. 31 has looked for an earnings decline of -3.9% for the S&P 500 (down from +3.5% at the start of the quarter). Earnings for 2023 also have been revised lower and sit at $225. Over the past few weeks, earnings expectations for the first and second quarters of 2023 accelerated their decline and now both point to year-over-year declines as well. On June 30, 2022, the estimated earnings growth rate for the first quarter of 2023 was 9.6%, and the estimated earnings growth rate for the second quarter of 2023 was 10.3%. By Sept. 30, 2022, the estimated earnings growth rate for the first quarter of 2023 was 6.3% and the estimated earnings growth rate for the second quarter was 5.1%. Today, the estimated earnings decline for the first quarter of 2023 is -0.6% and the estimated earnings decline for the second quarter is -0.7%. What does this all mean? To Orton, it says that analysts aren’t overly optimistic and have been reacting to slowing economic signals. Could there be room to move estimates lower? Yes, especially the estimates for the third and fourth quarters of this year. But he said that will depend on guidance from management teams this quarter. It’s also another piece of evidence that perhaps the earnings apocalypse we hear so much about may not materialize (yet again).

Guidance also will be critically important to getting a better sense for the decline we’ll experience on earnings and margins. Peak inflation is undoubtedly good news for price-to-earnings (P/E) multiples and suggests the great de-rating in 2022 is most likely behind us. But will there be collateral damage alongside the fall in inflation? Good news on lower inflation has not historically been good news for corporate profit margins: The prices-paid component of the Institute for Supply Management’s manufacturing Purchasing Managers’ Index tends to lead U.S. earnings before interest and taxes (EBIT) margins by six months and does not paint a pretty picture for profits in 2023. National Federation of Independent Business data released last week also highlights that more companies in the survey plan to raise wages more than they plan to raise prices. So where are margins most extended? In the United States, the majority of sectors are trading above their long-run average margins, with deep cyclicals that have benefitted from higher commodity prices the standout. Energy and materials’ EBIT margins are about 700 basis points above their long-run average. The only sector where EBIT margins are below their long-run average and P/E multiples are below their 25-year average is healthcare.

Can we believe the recent outperformance of international equities?

International developed equities outperformed U.S. equities last year and continue to outperform in 2023. Emerging markets also staged a strong recovery in the fourth quarter that continues this year. After years of underperformance and head fakes, Orton asks: Can we actually trust the recent outperformance? It’s amazing how many strategists have suddenly changed their tune, he said, declaring this is the time for international. Orton said he has liked emerging markets for the past few months and continues to believe in the potential for further outperformance. But he said he believes there is still a lot of uncertainty with respect to international developed equities, and at a minimum we need to get through earnings season to see whether the newfound optimism is sustainable. Regarding emerging markets, China’s dramatic U-turn on its restrictive COVID-19 policies has led to a massive rally in Chinese equities and there is room to catch up for other Asian economies as trade and business re-open. Orton said he remains cautious about adding to China here, but he said he would be more optimistic on a meaningful pullback. India still looks attractive to Orton and the recent pullback in his view makes this a better entry. Overall, there is still a significant valuation discount, which coupled with the opportunity for a resurgence in growth across select countries, makes emerging markets attractive in 2023, he said.

Emerging market valuations still look attractive
Ratio of price to earnings (P/E) over the last 10 years

Emerging market valuations still look attractive Ratio of price to earnings (P/E) over the last 10 years

Source: Bloomberg, as of 1/13/2023

What to watch

Expect a busy calendar of economic data releases and earnings results from companies in banking and financial services; airlines; energy infrastructure; building supplies; consumer goods; and streaming entertainment. The Empire State Manufacturing Survey will be released on Tuesday followed by the U.S. Producer Price Index and retail sales on Wednesday. We also have a heavy calendar of Fed speakers who Orton said could play an important role in setting the market direction given the recent loosening in financial conditions. U.S. debt-ceiling headlines could also become important as the government is roughly $78 billion away from breaching the $31.4 trillion limit.

This week's data releases

Monday China property prices; Japan producer price index; Australia inflation; Israel gross domestic product
Tuesday U.S. Empire State Manufacturing Survey; Germany consumer price index and ZEW Financial Market Survey; U.K. unemployment; China gross domestic product, retail sales, industrial production, and jobless rate; Italy consumer price index; Canada consumer price index and housing starts
Wednesday U.S. Mortgage Bankers Association Weekly Applications, retail sales, Producer Price Index, industrial production, and business inventories; Eurozone Harmonised Index of Consumer Prices; U.K. Consumer Prices Index; Canada industrial product prices
Thursday U.S. initial jobless claims, housing starts, and Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey; European Central Bank monetary policy account; Japan trade
Friday U.S. existing home sales; Germany producer price index; Retail sales from U.K. and Canada

 

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 Carillon Tower Advisers 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.

A 60/40 portfolio is based on a widespread investment strategy calling for a portfolio allocation of 60% equities and 40% bonds or other fixed-income securities.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

An out trade is a trade that can’t be completed because the information sent by the parties of the trade to the clearinghouse is wrong or incomplete.

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 “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy” is an aggregate of prices paid by urban 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 measures of economic activity such as price trends or gross domestic product include all economic activity and are often referred to as nominal measures. Real measures of economic activity are adjusted for inflation, in some cases by excluding more volatile prices for things like food and fuel.

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%.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

Growth at a reasonable price (GARP) is a stock investment strategy that seeks to combine tenets of both growth and value investing in the evaluation and selection of individual stocks. GARP investors look for companies with consistent earnings growth above broad market levels but try to avoid companies with very high valuations. By trying to avoid the extremes of either growth or value investing, GARP investors often end up focusing on growth-oriented stocks with relatively low price-to-earnings multiples in normal market conditions.

Investment-grade refers to fixed-income securities rated BBB or better by Standard & Poor’s or Baa or better by Moody’s.

High-yield bonds have credit ratings below BBB- from Standard & Poor’s or below Baa3 from Moody’s. High-yield bonds pay higher interest rates because they have lower credit ratings than investment-grade bonds.

Tail risk describes a form of portfolio risk associated with the increased possibility that an investment will move more than three standard deviations from the mean in a normal distribution. Left tail risks refer to unusually large losses. Right tail risks refer to unusually large gains.

A consensus estimate is a forecast of a public company’s projected earnings based on the combined estimates of all equity analysts that cover the stock.

The price to earnings ratio (P/E) measures a company’s current share price relative to its per-share earnings.

A multiple, sometimes referred as the price multiple or earnings multiple, is a measure of a company’s value based on the ratio of its current share price to its earnings per share. This ratio is known as the price-to-earnings ratio, or P/E.

De-rating is a term used to describe what happens as investors become less willing to pay for a company’s shares of stock and its future earnings, often because a metric such as the price-to-earnings ratio (P/E) has gone down or contracted, suggesting that the company faces the prospect of lower earnings in the future.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

Earnings before interest and taxes (EBIT), also known as operating earnings, operating profit, or profit before interest and taxes, can be calculated as revenue minus expenses excluding taxes and interest.

The National Federation of Independent Business’s Small Business Optimism Index surveys small and independent business owners on 10 equally weighted and seasonally adjusted variables, including their hiring, investment, and inventory plans, as well as on their economic expectations, assessment of the state of the economy, labor market, credit conditions, and earnings trends. The monthly change of each variable contributes proportionally to the overall monthly change in the index.

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.

The Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York.

The U.S. 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.

The Japan Services Producer Price Index, released monthly by the Bank of Japan, tracks changes in prices paid for services that include advertising; leases and rentals; real estate services; transportation and postal activities; information and communications; finance and insurance; sewage and waste disposal; motor vehicle and machinery repair; health and hygiene; call centers, hotels, and architectural, civil engineering, legal, accounting and other professional services.

The German Consumer Price Index is a monthly report on Germany’s inflation rate released by the Federal Statistical Office and based on prices paid for a wide range of goods and services including energy, food, and rents.

The ZEW Financial Market Survey is produced monthly by the Zentrum für Europäische Wirtschaftsforschung (the Center for European Economic Research) and is based on a survey of about 350 economists and analysts on the economic future of Germany in the medium term.

The Italy Consumer Price Index, released monthly by the Italian National Institute of Statistics (ISTAT) measures changes over time in prices for a representative basket of goods and services consumed by Italian households.

The Canada Consumer Price Index (CPI), released by Statistics Canada, represents changes in prices as experienced by Canadian consumers. It measures price change by comparing, through time, the cost of a fixed basket of goods and services that are divided into eight major components: Food; Shelter; Household operations, furnishings and equipment; Clothing and footwear; Transportation; Health and personal care; Recreation, education and reading; and Alcoholic beverages, tobacco products and recreational cannabis. CPI data are published at various levels of geography including Canada; the 10 provinces; Whitehorse, Yellowknife, and Iqaluit; and select cities.

The Mortgage Bankers Association Weekly Applications covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.

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 U.K. Consumer Prices Index is a measure of consumer price inflation in the United Kingdom based a wide range of household spending, including on food, alcoholic beverages and tobacco, clothing and shoes, housing and utilities, health, transportation, communication, recreation, education, restaurants and hotels, and miscellaneous goods and services.

The Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey is a monthly survey in which manufacturers in the Third Federal Reserve District, which includes Pennsylvania, New Jersey, and Delaware, indicate the direction of change in overall business activity and in various measures of activity at their plants: employment, working hours, new and unfilled orders, shipments, inventories, delivery times, prices paid, and prices received.

European Central Bank monetary policy accounts cover the monetary policy meetings of the bank’s Governing Council, which are normally held every six weeks. The accounts include a review of financial, economic, and monetary developments and policy options as well as a summary of the discussions and decisions. The accounts typically are published four weeks after the meetings.

The German Producer Price Index is compiled by Germany’s Federal Statistical Office on a monthly basis to track the prices of industrial products that include energy, capital goods such as machines and vehicles, intermediate goods such as raw materials, wood, metals, chemicals, and electronic intermediate circuits, and non-durable consumer goods such as butter, sugar, pork, poultry and crude vegetable oils.

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 75% 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.

 

RJIM23-0031 Exp. 5/17/2023


Jan. 9, 2023: Bad news is not good news (yet)

Last week’s price action in U.S. equities is a reminder that volatility is here to stay in 2023.

“The market is operating in this bad news is good news scenario, and I just think it’s presumptive to be there,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “Bad news is bad news.”

For now, there have been plenty of contradictory signals between the U.S. Federal Reserve (Fed) minutes and various economic data releases. That, Orton said, has contributed to erratic price action and has placed even more importance on the upcoming earnings season and guidance from management teams to set the direction of the market. While it was encouraging to see some consolidation in equities over the past few trading days, there are still plenty of risks, which is why Orton said he continues to favor maintaining a core defensive bias. The technical set-up remains challenged despite some positive gains on Friday, and he said it will be incredibly difficult for the market to sustainably break out with the wide divergence between what the Fed is saying and how the market is positioned.

Quote
Earnings season could end up being somewhat constructive in that we get decent results and guidance that isn’t apocalyptic.


“In fact, I believe one of the biggest risks is that the market continues to fight the Fed by expecting rate cuts in the second half of 2023 despite clear and repeated pushback,” he said. “What we as investors think the Fed should do and what the Fed actually does are getting confused and need to be reconciled at some point. The contradictory data of last week certainly won’t change any minds on the Fed regarding the current trajectory, and future economic reports like Thursday’s Consumer Price Index (CPI) will keep event volatility high.”

Friday’s positive price action makes sense given a “Goldilocks” jobs report with lower wages and higher participation, but Orton said it’s premature to think about a “pivot” and unlikely that many on the Federal Open Market Committee will adjust their February vote from 50 to 25 basis points (bps). Further, the Institute for Supply Management’s unexpectedly dismal Services ISM® Report on Business® also isn’t enough to alter the current path.

“Bad news is not good news here; it’s just bad,” Orton said. In the ISM services print, where levels below 50 indicate a contraction in the services sector, new orders tumbled hard from 56 to 45.2, taking it (as well as the headline number) to the lowest levels since May 2020. Prices paid, on the other hand, remained quite high, illustrating some of the dilemma that will likely confront the Fed as the year progresses. The Fed minutes last week confirmed the commitment to higher for longer, stating that “no participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023.” Orton said he finds markets too optimistic that the Fed will blink with further economic deterioration. Core services inflation remains stubbornly elevated and the labor market is still tight, he said, both of which will keep Fed Chairman Jerome Powell’s foot on the brake (even if investors think they should be pausing here).

“We’re down to the market pricing in a Fed increase of 33 basis points, as opposed to a 50-basis point hike,” Orton said. “I don’t see the Fed not pushing back when 17 of 19 Fed members have forecast a terminal rate above 5%. One data point likely won’t change their mind to say, ‘Okay, let’s downshift again to 25.’ ”

Services ISM Report on Business dropping
below 50 is consistent with recession


Services ISM Report on Business dropping below 50 is consistent with recession

Source: Bloomberg, as of 1/9/2023

Being defensive has continued to work and Orton said he expects that this will likely remain the case going forward, especially as earnings season kicks off with some of the big banks reporting on Friday. While some of the more beaten-down sectors like communication services, consumer discretionary, and materials outperformed the market last week, dividend growth and growth at a reasonable price (GARP) also did so.

“I actually believe earnings season could end up being somewhat constructive in that we get decent results and guidance that isn’t apocalyptic,” he said. “Earnings expectations continue to get revised lower, setting up the potential for specific companies to rally on solid results. Keep an eye on net profit margin which is expected to decline to 11.5% in the fourth quarter, but unexpected signals of additional pressure could be problematic and send the market to retest the October lows.”

Quote
One of the biggest risks is that the market continues to fight the Fed by expecting rate cuts in the second half of 2023 despite clear and repeated pushback.


Labor data was encouraging for a soft-ish landing

Payrolls data on Friday painted a positive picture of a labor market that remains robust, but with encouraging signs on wage inflation. Headline payroll growth was slightly better than expected at 223,000 jobs added, and while the unemployment rate dropped to 3.5% — indicating ongoing labor market tightness — ancillary indicators were more friendly. Wage growth came in a little lower than expected at 0.3% on the month, and prior figures were revised down from 0.6% to 0.4%. Meanwhile, participation jumped from 62.1% to 62.3%, which Orton said is very important given persistently low readings and concerns that the economy is running out of potential workers.

It’s worth noting, however, that underlying details showed a narrowing pace of job creation, a sizeable outflow of temporary workers, downward revisions to prior months, and a decline in the workweek reflecting diminished demand for labor more broadly. Crucially, wage growth not only printed below expectations but was revised lower over the prior two months, erasing what looked to be an accelerating trend. At the margin, the jobs report may ease the pressure to hike interest rates by 50 bps on Feb. 1, but policymakers appear to be increasingly frustrated by market pricing that’s at odds with Fed signaling in terms of both the terminal funds rate and timing of initial rate cut. Orton said this could push Fed officials toward a more forceful response at the next meeting.

The case for (higher quality) small-caps

Small caps have been persistently challenged over the past year. After dramatically outperforming in late 2020 and early 2021, performance down the market cap spectrum has left a lot to be desired. In fact, the Russell 2000® Index had its worst first 9-month performance on record and closed the year down more than 20%. The Russell 2000 now represents less than 4% of the U.S. equity market: lower, even, than after the tech bubble burst in 2000. Even though we’re heading into an economic slowdown and a likely recession, Orton said he believes small caps already discount a pretty severe recession. In fact, he noted, higher quality small caps, as represented by the S&P 600 Index, are at historically cheap levels that are consistent with severe recession. Current valuations would imply an ISM manufacturing Purchasing Managers’ Index well below 40, which only occurred during the 2008 financial crisis. Forward returns from the highly challenging environment in which small caps have been for the past 12-plus months also look compelling, he said.

What to watch

Earnings season kicks off this week with big banks and financial services taking center stage, plus reports from companies in pharmaceuticals; big box retailing; grocery stores; home building; managed healthcare and insurance; and airlines. On Thursday, the key focus will be on whether the downward trend on CPI core services inflation could alter the consensus view that the Fed will hike rates by 50 bps in February and another 25 bps in March before going on hold. The annual J.P. Morgan Healthcare Conference also could feature many pre-announcements and guidance updates for the sector.

This week's data releases

Monday Unemployment from the Eurozone and Italy; Germany industrial output; China money supply; Mexico Consumer Price Index (CPI)®
Tuesday U.S. wholesale inventories; Industrial production from France, Spain, and Turkey; Japan household spending, CPI from Tokyo and Brazil
Wednesday China foreign direct investment; Japan Leading Economic Index; Australia retail sales and CPI
Thursday U.S. CPI and initial jobless claims; China CPI and Industrial Sector Producer Price Index; India CPI
Friday University of Michigan Index of Consumer Sentiment; U.K. monthly gross domestic product and industrial production; Eurozone industrial output; CPI from France and Spain; Canada existing home sales; Brazil economic activity

 

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 Carillon Tower Advisers 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.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

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 “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy” is an aggregate of prices paid by urban 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.

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%.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

Growth at a reasonable price (GARP) is a stock investment strategy that seeks to combine tenets of both growth and value investing in the evaluation and selection of individual stocks. GARP investors look for companies with consistent earnings growth above broad market levels but try to avoid companies with very high valuations. By trying to avoid the extremes of either growth or value investing, GARP investors often end up focusing on growth-oriented stocks with relatively low price-to-earnings multiples in normal market conditions.

Headline measures of economic activity such as price trends or gross domestic product include all economic activity and are often referred to as nominal measures. Real measures of economic activity are adjusted for inflation, in some cases by excluding more volatile prices for things like food and fuel.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

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.

Forward earnings per share is an estimate for the next period’s earnings per share for a company’s profit divided by the outstanding shares of its common stock.

The Mexico Consumer Price Index, released monthly by the Instituto Nacional de Estadística Geografia e Informática (INEGI), tracks prices paid by consumers for a range of goods and includes core and non-core components. Non-core components are subject to higher price variability as in some cases they can be influenced by factors such as international references for certain livestock products, government administrative decisions on vehicles, property, or gasoline, and weather conditions affecting agriculture.

The Tokyo Consumer Price Index, excluding fresh food, is released by the Statistics Bureau of Japan and tracks a range of consumer prices in the Tokyo metropolis.

The Japan Leading Economic Index, released by the Cabinet Office of the national government of Japan, tracks economic indicators in more than a dozen categories, including inventories, new job offers, machinery orders, housing construction, consumer confidence, stock prices, money supply, the investment climate, operating profits in manufacturing, government bond yields, and sales forecasts for small business.

The Australian Consumer Price Index is a quarterly report from the Australian Bureau of Statistics measuring household inflation. It includes statistics about changes in price for a wide range of categories of household spending.

The China Consumer Price Index (CPI), released monthly by the National Bureau of Statistics of China, measures changes over time in prices of goods and services in eight categories and 268 basic divisions covering consumption by urban and rural residents, including food; tobacco and liquor; clothing; residential costs; household articles and services; transportation and communication; education, culture, and recreation; healthcare; and other articles and services.

The China Industrial Sector Producer Price Index (PPI) is released monthly by the National Bureau of Statistics of China and reflects the trend and level of prices change when the products are sold for the first time. The survey of industrial producers covers the prices of industrial products in 40 major industrial categories and more than 1,300 basic categories.

India’s Consumer Price Index measures change over time in general level of prices of goods and services that households acquire for the purpose of consumption. It is produced by the Price Statistics Division of the National Statistical Office in the Ministry of Statistics and Programme Implementation.

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.

The France consumer price index, published by the National Institute of Statistics and Economic Studies, is the instrument used to measure inflation. It allows the estimation of the average variation between two given periods in the prices of products consumed by households. It is based on the observation of a fixed basket of goods updated every year. Each product has a weight in the overall index that is proportional to its weight in household expenditure.

Spain’s Consumer Price Index, published by the National Statistics Institute, seeks to provide a statistical measurement of the evolution of the set of prices of goods and services that the resident population in family dwellings in Spain consumes. This index is compiled with nearly 210,000 prices reported by some 29,000 establishments distributed in 177 municipalities throughout the country. The data collection on 462 items is carried out in the traditional way (by personal visit to the establishments on the corresponding dates), as well as by telephone and e-mail. In addition, by automated means (such as scanner data or web scrapping), data is collected for another 493 items. For some tariffed items, information is obtained from the corresponding official publications.

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 75% of the investable U.S. equity market.

The S&P 600 Index is an index of small-cap stocks managed by Standard and Poor’s. It tracks a broad range of small-sized companies that meet specific liquidity and stability requirements.

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 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark 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.

 

RJIM23-0018 Exp. 5/9/2023


Jan. 3, 2023: What could go right?

The new year opens with a full menu of very real challenges that no one should discount, but it is still worthwhile to try to identify and be ready for things that could go well in 2023, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

There is no shortage of negative takeaways from 2022: The S&P 500 Index closed last year with its worst annual performance since the Global Financial Crisis in 2008, falling nearly 20% in 2022; the Nasdaq Composite Index lost a third of its value with a 33% drop for the year; while the 60/40 portfolio suffered one its worst years since World War II. Unfortunately, the changing of the calendar doesn’t reset many of the fundamental challenges that investors will continue to face well into 2023. The economy is slowing and corporate earnings estimates are coming down, all while inflation remains elevated and the labor market remains tight enough to compel the U.S. Federal Reserve (Fed) to continue its policy-tightening campaign in the beginning of 2023. Investors keep hoping for a Fed pivot, but Orton said he just doesn’t see that happening in the first quarter of the year. The December Federal Open Market Committee (FOMC) minutes to be released on Wednesday should further affirm a hawkish tone as policymakers shrugged off recent weaker than expected Consumer Price Index (CPI) data and were not satisfied with the pace of cooling in the labor market, leading 17 of 19 FOMC participants to anticipate an above-5% terminal rate in the committee’s Summary of Economic Projections. This intersection of the inflation narrative with concerns over slowing economic growth will likely fuel continued market volatility, Orton said.

Quote
I would expect this trend of stronger active manager performance to continue in 2023 as volatility remains high and companyspecific fundamentals will be most important to driving returns.


The technical backdrop is similarly uninspiring to start the year. Santa Claus didn’t come to Wall Street, leaving the S&P 500 below its 50-day and 200-day moving averages and continuing to consolidate around some key support near the 3800 level. Market breadth, price, and momentum have all rolled over but do not point to oversold conditions that would warrant a sharp bounce. Financial conditions also have tightened over the past few weeks, which Orton said is the opposite of what we need to see in order to gain confidence that any bounce can turn into a more sustainable rally. Until earnings season kicks off in earnest at the end of next week with the banks, he said he believes it will be incredibly difficult for the market to break out to the upside.

While none of this is very uplifting, Orton said it’s important to recognize the challenges we face and remind ourselves that nothing changes just because we hit the reset button on the annual performance calculator. And that is why he said he continues to favor maintaining a core defensive bias and leaning into quality. At the moment, there is nothing unique about staying on guard.

“It has become consensus to be bearish,” he said. “Market headwinds are all very well-documented, and it’s rare to engage in a discussion that doesn’t focus on left-tail risks. And it’s because of this pervasive negativity that I believe we need to be more thoughtful about what could go right in 2023. This isn’t intended to minimize any of the very real challenges, but given bearish positioning and consensus expectations for a challenging first half of the year, there are certainly some right-tail risks that we would do well not to forget in this new year.”

Valuations and earnings

We started 2022 with many sectors and industries priced for perfection, but after a vicious multiple compression over the past 12 months Orton said there are many parts of the market that are now discounted for despair. Some are falling knives, and some are going nowhere until the Fed ultimately pauses the current rate hiking cycle, but he said many other companies have strong underlying businesses and have simply been thrown out with the bathwater. More than 15% of the constituents of the S&P 500 are trading with single-digit price-toearnings (P/E) multiples, with that percentage having crossed 20% during the selloffs in the spring and late summer. The market as a whole is now much more reasonably priced, with the S&P 500 trading at a 17.5x forward P/E, down from a peak of 27x in 2020. The Nasdaq has had an even sharper multiple compression, peaking at over 35x forward earnings and now trading around 20x, a bit below the 10-year average. The key question is whether valuations are now reasonable enough, especially as the Fed tightens further. But with elevated levels of cash sitting on the sidelines, Orton said it’s conceivable that investors could start putting money back to work in some of cheaper parts of the market where fundamentals are disconnected from valuations.

More 'deep value' companies remain after
significant multiple compression


More 'deep value' companies remain after significant multiple compression

Source: Bloomberg, as of 12/30/2022

Valuations have normalized and don't need to 'crash'
to levels many are calling for, Orton says


Valuations have normalized and don't need to 'crash' to levels many are calling for, Orton says

Source: Bloomberg, as of 12/30/2022

Stronger than expected earnings or more clear signs of a “softish” landing also could be the catalyst to put this money to work. The earnings apocalypse that has been predicted quarter after quarter has yet to materialize and Orton said he wouldn’t be so sure that it will actually come. Originally, the earnings decline was expected to be driven by companies not being able to keep up with inflation with prices paid surging and prices received lagging (the marginal cost argument). This played out in some parts of the market like consumer discretionary, where earnings came down more than 20% from their peak in the first half of the year. But across most of the market, margins held up remarkably well. And now with supply chains in much better shape, Orton said the marginal cost argument has mostly played out. Coming into 2023, many analysts expect the lagged effects of monetary policy to cause a big drop in final demand as consumers finally cut back on spending in a meaningful way, which would cause earnings to come down. If that is not the case, Orton said earnings probably won’t fall significantly in 2023. Part of the reason why they have not fallen that much in inflationary recessions in the past is because there tends to be stronger nominal growth that helps offset against fixed cost increases.

It’s also worth noting that net revisions have actually been quietly moving lower over the past few months. The 1-year forward S&P 500 earnings estimate has slowly worked its way down from $229 to $220, and fourth-quarter expectations have come down sharply. Analyst expectations for fourth-earnings growth have moved from +3.7% to -2.8% over the last quarter, a meaningful decline not seen over the past two years. As usual, it will be the guidance that matters most in the upcoming earnings season, particularly commentary around how demand has held up over the past few weeks and management outlook going forward, Orton said.

Openings for active management

Despite challenged returns on an absolute basis, active management actually had its best year since 2007. Increased dispersion with sectors and industries provided opportunities for stock picking to shine. There was a 99.46% difference between the best- and worst-performing sectors in the S&P 500. Energy was up +59.04% versus a -40.42% drop in communication services: one of the widest performance ranges on record. The performance gap was even wider in the small- and mid-cap space, which Orton said was perhaps why active managers down market cap in particular were able to outperform. Proper stock selection and risk management across sector and industry weights finally mattered again. Additionally, the underperformance of the mega-cap names finally allowed active managers in the large-cap space to deliver positive attribution without simply overweighting five or six names. Increased scrutiny on valuation and pretty consistent performance of momentum factors also enabled quantitative managers to stage a comeback.

“I would expect this trend of stronger active manager performance to continue in 2023 as volatility remains high and company-specific fundamentals will be most important to driving returns,” he said.

A soft(-ish) landing?

Consumer spending has remained solid, boosted by experienceeager Americans splurging on services. While robust wage growth has supported consumer spending over the past year, cracks are forming that will likely worsen as the year progresses, thanks to rising interest rates. Imports are falling rapidly along with a swift (and likely involuntary) rise in inventories: a warning sign that solid consumer demand may be losing some steam going into 2023. But the labor market is loosening only gradually, in line with low jobless claims and the latest survey data suggesting jobs remain plentiful.

While this presents a challenge for the Fed, Orton said he sees it as marginally positive for the economy, even if it means rates need to be higher for longer. We’ll get a lot of jobs data this week and it will be important to follow any surprising developments, he said.

Manufacturing is also softening, consistent with an elevated probability of recession, but services continue to hold up. Orton said he expects that the December Institute for Supply Management (ISM) report will likely show the factory sector continuing to prepare for weak future demand as the Fed continues to tighten policy. Regional survey capital expenditure intentions have been on the decline and ISM-adjusted regional data has pointed to another sub-50 reading in December, suggesting that the manufacturing economy generally is declining. Orton said he expects that the non-manufacturing ISM likely remained relatively upbeat in December amid strong consumer demand. The latest personal spending figures for November showed that most major categories within services posted increases, with food services and accommodation showing the largest gains. Continued resiliency in services spending could mean upside to earnings and also help prevent some of the more dire economic predictions, he said.

What to watch

Things get busy quickly during the first trading week of the year as economic data releases pick up, including the December jobs report on Friday. Several FOMC members have speeches scheduled at the end of the week that could impact sentiment.

This week's data releases

Monday Spain unemployment; S&P Global/BME Germany Manufacturing Purchasing Managers Index (PMI)®
Tuesday U.S. construction spending; Germany inflation, unemployment; Caixin China General Manufacturing Purchasing Managers Index
Wednesday U.S. FOMC minutes, Institute for Supply Management® Purchasing Managers Index®, Mortgage Bankers Association Weekly Applications, MBA mortgage applications, and Job Openings and Labor Turnover Survey (JOLTS); France inflation; Japan vehicle sales; Caixin China General Services PMI
Thursday U.S. initial jobless claims and ADP® National Employment Report; Eurozone producer price index; Italy inflation; U.K. Bank of England decision-maker survey; Brazil industrial output
Friday U.S. nonfarm payrolls and unemployment; Canada joblessness; Eurozone Harmonised Index of Consumer Prices; Germany factory orders; Brazil inflation; Chile and Taiwan consumer price indexes; India gross domestic product

 

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 Carillon Tower Advisers 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.

A 60/40 portfolio is based on a widespread investment strategy calling for a portfolio allocation of 60% equities and 40% bonds or other fixed-income securities.

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

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.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

The Summary of Economic Projections is produced following meetings of the Federal Open Market Committee and includes meeting participants’ projections of the most likely outcomes for real gross domestic product growth, the unemployment rate, and inflation for a forward-looking three-year window and over the longer run.

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

The daily moving average (DMA) is a calculation that takes the arithmetic mean of a given set of prices over the specific number of days in the past; for example, over the previous 15, 30, 100, or 200 days.

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.

Oversold is a term used to describe a security believed to be trading at a level below its intrinsic or fair value.

A falling knife is a saying used in investing to describe a rapid drop in the price or value of a security. The admonition against trying to catch a falling knife is a way of saying that an investor should wait for a price to bottom before buying a security that could either rebound or lose all of its value if the company issuing it goes into bankruptcy.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

Tail risk describes a form of portfolio risk associated with the increased possibility that an investment will move more than three standard deviations from the mean in a normal distribution. Left-tail risks refer to unusually large losses. Right-tail risks refer to unusually large gains.

A multiple, sometimes referred as the price multiple or earnings multiple, is a measure of a company’s value based on the ratio of its current share price to its earnings per share. This ratio is known as the price-to-earnings ratio, or P/E.

Multiple compression is an effect that takes place when a company’s earnings rise, but its stock price does not move in response. This decreases the company’s financial multiple, and this often reflects a change in investor expectations. In the case of a company that posts flat earnings, a multiple compression could see the stock price fall or, in the event that the company reports falling earnings, the stock price could fall faster than the earnings.

Price-to-earnings (P/E) ratios measure a company’s current share price relative to its earnings per share. The ratio is used to help assess a company’s value and is sometimes referred to as the price multiple or earnings multiple.

Forward price-to-earnings (forward P/E) is a version of the ratio of price to earnings that uses forecast earnings for the P/E calculation. The earnings used in this ratio are an estimate and therefore are not as reliable as current or historical earnings data.

The marginal cost is the incremental expense to a company when it makes one additional unit of a product or service. Marginal cost analysis helps companies identify the point at which it can achieve cost-saving economies of scale.

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.

Final demand refers to the price paid by a consumer for a product or service, as opposed to intermediary or wholesale costs that are paid by the producer to create the product or service.

Nominal measures of economic activity such as price trends or gross domestic product include all economic activity and are often referred to as headline measures. Real measures of economic activity are adjusted for inflation, in some cases by excluding more volatile prices for things like food and fuel.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

The S&P Global/BME Germany Manufacturing PMI® is compiled by S&P Global from responses to questionnaires sent to purchasing managers in a panel of around 420 German manufacturers. The panel is stratified by detailed sector and company workforce size, based on contributions to gross domestic product.

The Caixin China General Manufacturing Purchasing Managers Index (PMI), compiled by IHS Markit, tracks supply and demand, manufacturing production, output, new orders, employment, and other measures of economic activity in China’s manufacturing sector.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

The Mortgage Bankers Association Weekly Applications covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.

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 Caixin China General Services PMI, compiled by IHS Markit, tracks sales, employment, inventories, and prices in China’s services industry. It is based on data compiled from monthly replies to questionnaires sent to purchasing executives in more than 400 companies. Survey responses reflect the change, if any, in the current month compared to the previous month based on data collected mid-month. A reading above 50 indicates expansion, while anything below that points to contraction.

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.

The Eurozone industrial producer price index (PPI) tracks transaction prices for the monthly industrial output of various economic activities in the European Union. The index measures price changes from the seller’s perspective and serves as an early indicator of inflationary pressures in the economy and records the evolution of prices over longer periods of time.

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 Chile consumer price index, according to the International Monetary Fund, tracks changes to inflation and consumer prices over time paid by consumers in Chile.

The Taiwan Consumer Price Index, released monthly by the National Statistics Bureau of the Republic of China (Taiwan), tracks prices paid by Taiwanese consumers for a wide range of goods and services.

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 75% of the investable U.S. equity market.

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

 

RJIM23-0010 Exp. 5/3/2023