“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
The disinflationary path back to the Fed’s 2% target is proving to be more difficult than many predicted. This creates uncertainty around the timing and depth of interest rate cuts.
A key question now: Will momentum roll over, leading to a deeper correction, or will the equity market simply continue to correct through time?
Along with earnings, management team commentary about the strength of their consumers will be critically important.
“Uncertainty never feels good, and it’s certainly never a good thing for markets,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
“But,” he added, “it’s also no reason to lose your head, and it could offer investors an opportunity to consider starting to put money to work across a range of asset classes.”
The disinflationary path back to the U.S. Federal Reserve (Fed) 2% target is proving to be more difficult than many predicted, raising questions about the timing and depth of interest rate cuts. Rising cross-asset implied volatilities — a good barometer for macroeconomic uncertainty — are finally taking a toll, and heightened geopolitical tensions in the Middle East further add to the current level of unpredictability.
But for all this uncertainty, Orton said it’s worth noting that the S&P 500 Index is only 2.5% off its most recent all-time high, and that’s with 10-year U.S. Treasury yields having jumped more than 30 basis points over the same period.1 In the coming week, it will be critical to follow whether momentum starts to roll over, potentially leading to a deeper correction as weak hands are flushed out and short volatility positions are forced to unwind, or whether the market simply corrects through time as it has done for the past few weeks.
“I have been vocal over this period not to chase the market and to wait for a better entry point since it’s been a one-way street for the past five months,” Orton said. The S&P 500 is still up nearly 25% from the October lows of last year and this is the first breather the market has taken. “I think many investors have forgotten that markets go up and down. And I would argue that the fundamentals — a solid economic backdrop coupled with expanding earnings breadth — support further upside in 2024.”
There were plenty of opportunities across the broader market a few weeks ago, he said, and he believes there will be even more once the market finds some firmer footing.
“It never pays to panic when there is uncertainty,” Orton said. Rather, he suggests being ready to consider putting cash to work as the market inevitably settles and to evaluate using this as an opportunity to continue building balance in portfolios, especially with rates back to generationally attractive levels.
Inflation was the big story last week. Despite the sharp reactions in the market narrative whenever new data comes out that doesn’t fit with the consensus view, Orton notes that this is the third most rapid disinflationary cycle over the past 70 years. He said it was foolish for anyone to believe that the path from 9% to 4% could be linearly extrapolated back to the Fed target. The “last mile” is the most difficult and we’re seeing that play out, he said, adding that “the economy is too good to expect a rapid cooling.”
…and just like that we’re back to 4.5%
U.S. 10-year Treasury weekly candles, over the last year
Source: Bloomberg, as of 4/12/24
“I’d rather have an economy where people are working and spending than one with a more rapid policy-induced journey back to the artificial, yet dogmatically held, 2% inflation target,” he said. “And I have an inkling that Fed Chair Jerome Powell and other Fed officials get this, too. That’s why I think it’s preposterous hearing some people say that rate hikes could be back on the table.”
Orton said he still firmly believes that the question about the Fed’s rate-cutting cycle is when, not if, and the market should take solace in that. Equities didn’t really react to the rapid repricing of rate cuts at the start of the year, and we have some indigestion right now as reality around the economic backdrop sets in.
“It increasingly looks like we may only get one or two rate cuts this year, to which I say, ‘So what?’ “ Orton said. “I’ll reiterate my view that the market doesn’t need rate cuts to continue pushing higher.”
That’s because earnings have been and should continue to be the key driver of the market, he believes, and consensus expectations still feel a bit low to him in the more cyclical sectors that outperformed the broader market in the first quarter.
That said, Orton acknowledges that high-for-longer monetary policy will bite in some areas of the market. There are already crosscurrents developing in spending by more and less affluent U.S. consumers and this will only increase, but that simply means it’s important for investors to know what they own.
“If earnings deliver, as I suspect they will, risk assets can move higher,” Orton said.
Earnings season is off to a decent start despite the negative price action on Friday in response to the big banks, which came in with stronger than expected first-quarter results and solid guidance in the 2024 outlook. The headlines largely focused on net interest income, but Orton noted that it only decreased 0.7% on average across four of the biggest money center banks. Noninterest revenues were stronger — investment banking revenues are up and pipelines are growing — and we’re seeing lower provisioning for credit losses, a normalization in net charge-offs, and declining nonperforming asset levels. Unfortunately, with financials having rallied more than 30% heading into earnings season, investors expected perfection that they did not get. The rest of the big banks as well as the regionals are reporting this week and Orton said it’s probably not worth stepping in as a buyer until we’re through the news. Overall, if the U.S. economy is able to grow at more than 2% this year and if we get a rate cut or two from the Fed, he believes bank stocks can resume their solid performance.
Looking forward to the rest of earnings season, Orton said he is sticking with his estimate of 15% earnings per share (EPS) growth for 2024 and said he believes EPS growth over 8% is possible in the first quarter. Over the past 10 years, he said, we’ve seen a trend of meaningful upside growth from the end of the quarter through the end of the earnings season. Specifically, the earnings growth rate has increased by 5.5% on average over this period due to the number and magnitude of positive earnings surprises. If this average increase is applied to the estimated earnings growth rate at the end of the first quarter (March 31) of 3.4%, the actual earnings growth rate for the quarter would be 8.9% (3.4% + 5.5% = 8.9%).
This is not a time to panic, Orton said, but rather one to consider embracing some downside as an opportunity to consider eventually putting more money to work across asset classes. Higher rates are increasingly a challenge for market breadth to expand, so he said it’s important to watch where the 10-year Treasury yield eventually tops and if that’s enough for the average stock to find its footing. This week brings a number of earnings reports across sectors, along with commentary from management teams about the state of their consumers and their outlooks for demand. Earnings growth must continue to deliver, Orton said.
“Misses and negative outlooks probably will be met with sharp negative reactions given the run-up of the market into earnings season,” he said. “It’s all about delivering quality growth going forward.”
Against that backdrop, Orton’s investment playbook includes examining the potential of three areas:
Leaning into cyclicality. Increased geopolitical tensions should keep oil prices elevated, which will feed into revenue and EPS growth next quarter for the energy complex. Expectations for the sector remain depressed, and Orton believes there’s good potential for upside surprises, which is one reason why he continues to like energy even after the strong gains in the first quarter. Copper and gold miners also are in focus. Rising investments in data centers and artificial intelligence (AI) could boost the demand for copper on top of the ongoing role it plays in the production of electric vehicles and other electrification efforts. Consequently, Orton said he would look for higher-quality companies with exposure to copper as well as gold given a very strong pricing environment. He has a favorable outlook on industrials, and he believes the market taking a bit of a breather could help reset some overbought extremes across the sector. He also hopes earnings season provides a catalyst for some of the biggest winners across the space to reaffirm the current market narrative around data centers and capital expenditures. Orton said there are strong secular growth tailwinds for the electrical equipment industry and many high-quality companies with strong margins and free cash flow generation that investors could consider looking at on weakness if they don’t already have exposure.
Adding balance to portfolios. Investors have an opportunity to build portfolios that are better balanced between cyclical and secular growth as well to lock in attractive yields, Orton said. The recent increase in the U.S. 10-year yield in response to fading expectations for Fed rate cuts this year makes it more attractive for investors to think about leaning into longer durations in fixed income, he said. Sure, there are risks that rates can move higher, but Orton said he would argue that current rate levels are much more attractive from a risk/reward standpoint.
Additionally, he said recent weakness across the small-cap space provides a good entry point to evaluate the potential of positioning portfolios more aggressively for sustained economic growth. Watch to see whether the Russell 2000® Index can hold onto levels around 2000 heading into small-cap earnings season in the coming weeks. Valuation differentials with large caps remain near historic levels, and Orton believes earnings can start to improve and inflect higher in the second half of 2024.
International selectivity. The European Central Bank (ECB) left its interest rate policy unchanged at its April meeting but provided the clearest indication yet of an upcoming policy rate cut. The divergence between the Fed and other central banks is setting up an interesting dichotomy that Orton expects likely to keep the dollar strong and to support exporters across markets like Japan and Europe. International markets continue to perform well, with Japan continuing to be a source of strength and European equities sitting just below their all-time highs set earlier last week. European energy companies have lagged their U.S. peers, but Orton sees a path for them to catch up, while in the emerging markets complex countries like India are not following the global risk-off sentiment and instead reacting to idiosyncratic risks.
“There are some good diversification opportunities outside of the U.S. that are actually supported by improving fundamentals, not just a valuation argument,” Orton said. He continues to like financials across international markets, particularly in Europe and Japan. He does not believe an ECB easing poses a risk to European banks as his sense is that the ECB will err on the side of a gradual easing, particularly as the European economy seems to be re-gaining some momentum.
Tensions between Israel and Iran will remain in the spotlight, along with moves in oil prices and speculation around the potential inflationary impacts of the recent spike.
On the economic front, investors will focus on the March retail sales report, a reading on U.S. industrial production, housing starts, and existing home sales. Globally, watch for inflation updates from Canada, the U.K., and Japan.
Earnings season will continue to pick up pace with more large banks reporting early in the week followed by a large number of regional banks. We also get earnings reports from companies in pharmaceuticals and consumer products, health insurance, air travel, entertainment streaming, and semiconductor manufacturing. Even more important than the actual earnings reported will be the outlook and commentary from management teams around the outlooks for their businesses and the state of the consumers they serve, Orton said.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of April 12, 2024.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
A candle or candlestick chart uses differently colored candles to convey the size and direction of movements in price for a given variable. Patterns that occur irregularly in the chart are uses to help determine possible short-term price movements. Each candlestick has a wide part known as the real body, with the top of the body marking the opening price for the period being measured, and the bottom of the body marking the closing price for the period. In addition, lines above and below the real body denote the high and low for the price during the period being measured. A green candle represents a period when the closing price rose from the open. A red candle represents a period with a closing price that was lower than the opening price.
A charge-off is a debt that the originating lender or creditor has written off as a loss after concluding that it will not receive the money that it is owed.
A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.
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.
Disinflation refers to the temporary slowing of the pace of price inflation and describes what happens when the inflation rate is marginally lower over the short term. Disinflation refers only to the rate of change in the rate of inflation. In this, it is distinct from inflation and deflation, which describe the direction of prices.
Duration incorporates a bond’s yield, coupon, final maturity, and call features into one number, expressed in years, that indicates how price-sensitive a bond or portfolio is to changes in interest rates. Bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations.
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.
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.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
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.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
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.
Money center banks are large banks situated in economic hubs that primarily deal with governments, other banks, and big corporations.
Net interest income represents the difference between the revenue generated by a bank’s interest-bearing assets and the expenses associated with paying on its interest-bearing liabilities.
Overbought is a term used to describe a security or group of securities believed to be trading at a level above its or their intrinsic or fair value.
A policy rate is an interest rate set by a central bank or other monetary authority to influence the evolution of an economy’s monetary variables such as consumer prices, exchange rates, or credit expansion.
A risk-off asset is one that is considered to be a safe haven in bearish market environments. In contract, a risk-on investment is typically more fueled by a strong growth environment and is more apt to rise when good news fuels bullish sentiment and investor expectations of favorable risk/reward ratios.
Roll over, as it relates to investment returns, sector performance, or economic data, describes a widespread and unfavorable change in prices or data that begins slowly and picks up speed.
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.
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.
The Federal Reserve’s inflation target rate is the rate of price increases prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by Personal Consumption Expenditures (PCE) Price Index.
Weak hands is a term used in finance to describe investors or traders who either lack conviction in their strategies or who don’t have the resources to carry them out. Typically, the term is used to describe investors who are “shaken out” by normal price movements in the market because, motivated by fear, they sell their positions at virtually any sign of bad news.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-529417 Exp. 8/15/2024
While sticky recent inflation data suggests an increased chance for fewer rate cuts than what investors have currently priced in, fundamentals are what’s driving the broadening of this bull market.
Watch for the positive underlying economic trends highlighted by last week’s payroll report to feed through to first-quarter earnings and management outlooks in coming weeks.
Two key catalysts this week: The Consumer Price Index and the start of earnings season. Listen closely to management commentary from money center banks.
The strong March payroll report continues to highlight the resiliency of the U.S. economy and sends a positive signal as we head into the start of the first-quarter earnings season.
“It was encouraging to see the market react positively to the report. It seems that good news is good news once again,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “While some may continue to obsess over the timing of the U.S. Federal Reserve’s first rate cut and how good news might influence the Fed’s reaction, I believe that earnings are what really matter for the market’s direction in the near term.”
Orton expects good news on the economic front to feed through into the earnings results and management outlooks we’ll receive in coming weeks. Stronger economic growth also has supported commodities where price trends are becoming more positive, underpinned by concerns that supply is tightening versus demand. While earnings will be the ultimate arbiter of the bull market, Orton said it’s important to pay attention to bond yields that continue to press higher as well as to the impact that a hotter than expected Consumer Price Index (CPI) could have in the short term.
“With the 10-year U.S. Treasury yield closing in on 4.5% and the U.S. dollar moving up as a result, I wouldn’t chase the market higher until we get through the CPI report and the start of earnings season,” he said. “There is certainly a risk of a pullback given these developments, and we haven’t really seen any meaningful consolidation since October. That said, I firmly believe investors could benefit from using downside opportunistically, leaning into cyclicality, and diversifying portfolios as the market continues to broaden.”
Orton said there are plenty of opportunities across sectors, industries, and geographies where fundamental and technical trends are positive and that stand to benefit from a continuation of economic growth.
“Rather than fret about the timing and depth of Fed rate cuts, it’s time to accept that good news is good news and the underlying trends of this bull market remain firmly in place,” he said.
Interest rates haven’t been the headwind investors suspected,
but watch out as they approach 4.5%
Source: Bloomberg, as of 4/5/24
The March payroll report made clear that the appetite for labor remains strong and the breadth of hiring is improving, Orton said. At the same time, average hourly earnings continued to decelerate despite the robust hiring. That supports the Fed’s view, which sees more robust growth with inflation remaining contained. The March CPI report on Wednesday will provide further data regarding inflation and will be closely scrutinized given that we’ve already had two strong inflation reports to start the year and that markets still remain a bit stretched. It’s worth pointing out that the S&P 500 Index has had record sensitivity to CPI surprises over the past two years, dropping 73 basis points for each CPI surprise of one standard deviation.1 If the CPI comes in better than expected, this will likely move the consensus expectation back to a June rate cut, though Orton said surprisingly high inflation data likely would drive a breakout in yields and intensify uncertainty around sensible anchor levels for yields.
“Once markets settle, this could provide a good opportunity for both equity investors and those looking to lock in attractive long-term bond yields,” Orton said.
The kickoff of the first-quarter earnings season is the other big event of the week with some of the largest banks reporting on Friday. Orton said he doesn’t put too much stock in the initial reaction of banks but sees management commentary as very important to setting the tone. Banks are expected to report a year-over-year decline in earnings and to be the largest detractor to the financial sector’s growth in year-over-year earnings. We’re likely to see mixed spread revenue trends, relative strength in fee income, and further reserve-building amid a continued reversion to the mean in credit quality, he said.
Management commentary around the state of the consumer and the banks’ business clients will be very important to corroborating the resiliency in recent economic data, and Orton is curious to hear about expectations around a recovery in investment banking fees and the future pipeline of initial public offerings. Overall, according to FactSet, the estimated first-quarter year-over-year earnings growth for the S&P 500 is 3.2% with the estimated net profit margin accelerating to 11.5% (from 11.2%).
“Remember last year when the consensus was for margins to have deteriorated materially amid weak demand and fading pricing power?” Orton asked. “I never subscribed to that idea, but the easy money has now been made. Companies must continue to deliver to keep the fundamental trends underpinning this bull market in place.”
The fundamental drivers of the bull market remain in place, but Orton said we should be cognizant of the short-term risks posed by hawkish trends in interest rates and the dollar as well as by big rallies across the commodity complex. Earnings growth must deliver as well, and he expects to see a continuation of dispersion across the market as companies that beat and provide optimistic commentary will be rewarded while those that miss the market could face a sharp reaction from investors.
“It’s all about delivering quality growth going forward,” he said. With that in mind, Orton says he would consider:
Leaning into cyclicality. In light of energy’s recent strong performance, Orton continues to believe that the fundamentals support further upside, especially if crude prices don’t roll over. Gold miners are finally breaking out as well following the surge in gold prices this year. Most investors have missed the train, he said, and understandably so as pervasive low-quality management and unpredictable operations plagued these companies over the last decade. But COVID forced discipline and Orton said interest could continue to rise as these companies hit more investors’ radars. He also would remain overweight industrials, particularly in companies exposed to reshoring and investments in infrastructure and data centers. Data center demand is expected to grow 11% per year with upside risks from the adoption of artificial intelligence while the reshoring of semiconductor plants is already fueling mega-projects. Orton was on CNBC last week discussing the secular growth opportunities in the electrical equipment industry, which he said remain an attractive way to get exposure to industrials.
Adding to small cap positions. The Russell 2000® Index continues to set a path of higher highs and higher lows, giving Orton confidence that small caps could be on the verge of a meaningful breakout if risk-on sentiment remains in place. If the CPI is in line with expectations (or even a bit weaker), he said this could be a catalyst to see smaller companies outperform. For all the criticisms of companies down the market-cap spectrum, the Russell 2000 has rallied nearly 30% from the October lows but still remains nearly 16% away from its all-time highs in 2021. Valuation differentials with large caps remain near historic levels and Orton said he believes we can start to see earnings improve and inflect higher in the second half of 2024.
Being selective in international stocks. International markets have performed well, with Japan continuing to be a source of strength and European equities sitting just below their all-time highs set earlier last week. The path to rate cuts in Europe also looks more clear, with the European Central Bank expected to deliver the first cut in June followed by two more cuts in September and December. Orton said he likes Japanese financials over exporters at this point given the likelihood of a stronger yen in coming months. In addition, he said financials across Europe generally look attractive, especially on the periphery, which is in better shape over the core of the continent. He also finds emerging markets ex-China to be attractive, particularly India, where he has favored the auto and auto components industries for almost a year and still does.
Wednesday’s Consumer Price Index report for March. Headline CPI is expected to increase 0.4% month over month (flat from February’s report) and 3.1% year over year (lower from the prior month’s 3.2%). Core CPI is expected to decelerate on both a month-over-month and year-over-year basis to +0.3% and +3.7%, respectively.
Wednesday also brings the minutes from the Federal Open Market Committee’s March meeting.
On the earnings front, a major airline reports on Wednesday, followed Friday by reports from several large money center banks. Price action has been especially strong for the banks over the past month, so Orton expects management commentary and guidance to play a critical role in whether the upward march takes a breather.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of April 5, 2024.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.
Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.
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. Headline CPI inflation includes food and energy, while “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.
Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
Hawkish, dovish, and centrist are terms used to describe the monetary policy preferences or expectations of central bankers or market participants. 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.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Money center banks are large banks situated in economic hubs that primarily deal with governments, other banks, and big corporations.
A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.
Overweight describes a portfolio position in an industry sector or some other category that is greater than the corresponding weight level in a benchmark portfolio.
The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
Pricing power, also known as market power, refers to a company’s ability to manipulate the price of a product or service in the marketplace by controlling the level of supply, demand, or both.
Reshoring describes the effort to bring manufacturing and other services back to the United States from overseas operations.
Reversion to the mean, or mean reversion, refers to the statistical tendency of data to rise or fall toward its long-term average over time.
Roll over, as it relates to investment returns, sector performance, or economic data, describes a widespread and unfavorable change in prices or data that begins slowly and picks up speed.
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.
Standard deviation is a measure of the dispersal or uncertainty in a random variable. For example, if a financial variable is highly volatile, it has a high standard deviation. Standard deviation is frequently used as a measure of the volatility of a random financial variable.
Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing flexible data.
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.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-524067 Exp. 8/8/2024
Look for earnings — not the timing of Fed interest rate cuts — to drive market performance.
Anyone who says this is still a narrow market simply hasn’t been paying attention to its growing breadth and the renewed strength in insurance companies, banks, industrials, and energy companies.
Going back to 1928, any time the S&P 500 was positive every month from November to March, the S&P 500’s forward returns for the following nine months have been positive 12 out of 12 times. (Source: Bloomberg.)
The stickiness of recent inflation data highlights an increased likelihood of fewer interest rate cuts than are currently priced by the market, but does that really matter to the fundamental drivers of the bull market?
“I would argue no,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “The data still points to when — not if — the U.S. Federal Reserve cuts interest rates.”
At this point, the market has normalized its expectations, going from expecting more than six to less than three rate cuts in 2024 with strong gains across the equity complex. The narrow market that persisted into the start of this year also has broadened at the same time that investors have been forced to price a “higher for longer” environment with 10-year U.S. Treasury yields rising.
This unusual price action is the result of strong corporate earnings, which have continued to surprise to the upside with growth inflecting higher across a number of sectors, Orton said. Technology has remained a source of strength, but it’s not the only game in town anymore from a growth perspective. There is increasing strength beneath the surface in sectors like financials, industrials and materials, he said, and we’re seeing earnings growth bottom and start to inflect higher in places like energy.
“Whether the Fed cuts one, two or three times isn’t going to change the earnings results,” Orton said. “So when Fed Governor Christopher Waller says he’s in ‘no rush’ to cut rates and Fed Chair Jerome Powell reiterates this sentiment, I simply focus on the strength of the underlying bull market and favor using any downside we might get.”
The market is certainly overdue for a pull-back, Orton said, but that doesn’t mean one will necessarily come. Perhaps a push in the 10-year toward 4.5% or a further strengthening of the U.S. dollar might lead to some profit-taking, but he believes the underlying backdrop remains supportive for further upside in equities in the second quarter and beyond.
The strength in the first quarter was quite impressive with the S&P 500 Index rallying more than 10%.1 Market breadth has steadily increased for the past one to two months and Orton expects this to continue, especially with earnings season coming up.
“Anyone who says this is still a narrow market simply hasn’t been paying attention,” he said.
Energy has overtaken information technology as the second best-performing sector in the S&P 500 year to date with financials and industrials both outperforming. Sectors like materials and healthcare also have made good progress, but dispersion in these sectors has been quite high with a number of winners and some key losers:
The Magnificent Seven now contribute only 36% of the S&P 500’s gains while the top five stocks’ contribution is down to 49%.
More than 40% of the S&P 500’s constituents outperformed the index in the first quarter.
26% of the S&P 500’s stocks are up more than 15%, while 15% of constituents are up more than 20%.
While semiconductors and glucagon-like peptide 1 (GLP-1) weight loss drug companies are among the top performers, so are a number of insurance companies, banks, industrials, and energy companies.
“There have been plenty of opportunities to outperform year to date without being levered singularly to the artificial intelligence trade,” Orton said. “I believe we’re likely to see further rotation in the second quarter as new trends develop and fundamentals drive increased investor attention.”
Strong earnings results and guidance will be necessary to keep the positive momentum going, Orton said, with the estimated earnings per share (EPS) growth rate for the S&P 500 at 3.6%, according to FactSet.
Orton came into 2024 on the very high side of earnings estimates, expecting 15% EPS growth, driven by upside surprises in more cyclical and underperforming sectors where he believed that analysts were too pessimistic about the economy and demand. In the most recent fourth-quarter results, he believes that’s exactly what played out: Sectors like energy, consumer discretionary, industrials, and healthcare surprised meaningfully to the upside.
“With the economy likewise surprising to the upside and consumer demand remaining strong on the back of a relatively tight labor market, it’s likely this trend continues,” he said. “Perhaps we see investors ‘sell the news’ when we get to earnings season even if results are strong, but if that’s the case I would be a buyer on that weakness.”
Sectors like financials, which is up 34% since the October lows last year, are still barely above their last all-time high at the start of 2022. Even some of the Magnificent Seven are just above their last all-time highs.
Energy leaps ahead of tech
S&P 500 sector returns year to date, as of 3/28/24
Source: Bloomberg, as of 3/28/24
Given that the bull market has continued to push higher with five consecutive months of gains in the S&P 500, Orton highlighted a few statistics that he said could signal additional gains going forward.
Going back to 1928, according to Bloomberg, any time the S&P 500 was positive every month from November to March, the index’s:
Forward returns for the following nine months were positive 12 out of 12 times for an average return of 12.2% and a median return of 11.4%.
Returns in the following April were positive nine out of 12 times for an average and median return of 1.1%.
“Clearly, the degree of the current rally doesn’t occur too frequently, and it’s generally a harbinger of longer-term strength,” Orton said. “That’s because in nearly all cases the economy was moving from recession or stagnation back into expansion.”
It’s easy to forget how much economic growth slowed in 2022, which included two consecutive quarters of negative growth in gross domestic product along with a deep earnings recession across most sectors. With or without rate cuts, Orton said he is inclined to believe that the macroeconomic backdrop will remain in place and provide the supportive environment necessary to keep a perfect hit rate for the forward return statistic cited above.
There are many parts of the market that remain attractive from an asset allocation perspective, Orton said. It’s clear that the Fed wants to cut this year, and while it might not be in a rush to move rates lower, he said we can have confidence that short-term rates will eventually start to move meaningfully lower once the rate cutting cycle begins. That’s why Orton said he has been telling clients to have a plan for redeploying excess cash on the sidelines. Themes he likes include:
Small cap breakout? The Russell 2000® Index has made a series of higher highs and higher lows, giving Orton confidence that small caps could be on the verge of a meaningful breakout if risk-on sentiment remains in place. In fact, the Russell 2000 came close to making a two-year high to close the quarter following a nearly 30% rally off its October lows.
“I have been and remain bullish on the opportunities down the market-cap spectrum,” he said. “Despite the recent strength, small caps are still more than 13% off their all-time highs from 2021. Valuation differentials with large caps remain near historic levels, and I think we could start to see earnings improve and truly inflect higher in the second half of 2024.”
An overweight to cyclicality. Orton has said for the past few weeks that energy looked attractive as a complement to both growing exposure to information technology and rising oil prices. With that playing out nicely, he favors incorporating cyclicality into portfolios. In addition to industrials, he said materials look more interesting with surging prices for copper, gold and especially agricultural commodities. Big banks also have been on a tear and look, in Orton’s view, to be at a point where earnings growth is inflecting higher. He said the key when looking at cyclicality is to lean into quality, a key driver of the market throughout the rally off the lows of last October, and he expects that to continue.
International selectivity. International markets continue to perform well, with a significant breakout occurring in frontier markets, Orton said.
“I think this is a positive signal for risk appetite across the emerging market complex, and a continued improvement in economic sentiment can push overseas markets higher,” he said. “The MSCI EAFE® (Net) Index has been a source of strength and I continue to advocate for leaning into Japan. I like financials over exporters at this point given the likelihood of a stronger yen in coming months.”
Financials across Europe generally look attractive, he said, especially in the periphery, which is in better shape than in the core of the continent. He also likes emerging markets ex-China, particularly India, where he said the auto and auto components industries have been and remain attractive.
Russell 2000 flirting with its 2-year high with plenty of room to go
Russell 2000 returns, last three years
Source: Bloomberg, as of 3/28/24
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of March 28, 2024.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
As with all equity investing, there is the risk that an unexpected change in the market or within the company itself may have an adverse effect on its stock. The biggest risk of equity investing is that returns can fluctuate and investors can lose money.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
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 returns reflect returns that take place after a particular event or point in time.
GLP-1 weight-loss drugs, formally known as glucagon-like peptide 1 agonists, comprise a class of type 2 diabetes drugs that improve blood sugar control and may also lead to weight loss. The drugs mimic the action of a hormone called glucagon-like peptide 1 by stimulating the body to produce more insulin when blood sugar levels start to rise after someone eats. The additional insulin helps lower blood sugar levels, which helps in controlling type 2 diabetes. How GLP-1 agonists lead to weight loss is less clear.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 index. As of March 28, 2024, they were Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Overweight describes a portfolio position in an industry sector or some other category that is greater than the corresponding weight level in a benchmark portfolio.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
“Sell the news” is part of a common saying in securities trading: “Buy the rumor. Sell the news.” Traders who focus on news try to make profits through timely trading that anticipates or reacts to news about a company or other market-moving development.
Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing flexible data.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the United States and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to U.S. citizens but not applicable to citizens in the overseas country.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-520998 Exp. 8/1/2024
