Weekly Market Update

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Markets in Focus

Timely analysis of market moves and sectors of opportunity

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May 23, 2023: Being defensive doesn’t mean sitting on the sidelines

Gains across U.S. equities last week might have led some investors to think that progress was made on debt ceiling negotiations, or that economic data had provided some insights into the upcoming June decisions from the U.S. Federal Reserve (Fed). Unfortunately, that wasn’t the case.

Bond yields climbed last week, and the yield on the 10-year Treasury note reached its highest level since the collapse of Silicon Valley Bank in March. “The entire U.S. yield curve has shifted upward, but the change is most notable in the extremely short end,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“It seems that the yield curve is telling us there’s a rising chance the world’s largest economy will default in a couple of weeks’ time, but the Fed is unlikely to do much about it, and ultimately the U.S. economy will be stronger,” Orton said.

The Nasdaq Composite Index was up 3.5% last week – largely dominated by gains in mega-cap companies – which shows that climbing bond yields could not stop a tech rally. However, Orton noted that the gains are being led by only a handful of big names. These anomalies and others have encouraged Orton to continue to advocate for remaining more defensive, leaning into quality and low volatility companies.

Orton said that companies with strong free cash flow generation, consistency in analyst outlooks, and stability of earnings per share (EPS) growth are examples of quality investments that have outperformed the broader market of stocks. He also pointed out that being more defensive and leaning into quality does not mean shying away from risk.

“Those who have been sitting in cash or continuing to call for economic Armageddon have missed participating in some of the strong year-to-date upside,” Orton said. “It doesn’t matter whether you think the Nasdaq and S&P 500 Index gains are justified. That’s where we are.”

Leaning into quality means embracing diversification across asset classes. Orton noted that as economic growth continues to slow, it’s particularly important to focus on companies that can grow consistently. He continues to prefer health maintenance organizations and pharmaceuticals within the healthcare sector, aerospace and defense in industrials, and select high-quality tech companies. Orton also sees opportunities in emerging markets, focusing on Asia ex-China and India.

Orton expects quality and low volatility to be important in the future, particularly to help investors navigate the ups and downs of the wide trading range in which we’ve been stuck. “I just don’t see how this narrow market can continue in perpetuity,” he said. Citing the overlap between mega-cap companies and artificial intelligence (AI) development, Orton said that companies farther away from AI and AI-derived products have suffered from worse performance.

“I fully believe that AI will be incredibly transformative and some of the gains to share prices have absolutely been justified,” Orton said, “but the euphoria has become extreme.” He warned that there will be large costs associated with realizing the EPS benefits from AI, and this is not reflected in current valuations.

With economic data continuing to be resilient, Orton doesn’t see the Fed cutting rates in 2023. “I would expect to see some normalization as a result, which would likely cut the multiples of some of these high flyers as those assets are redeployed into the broader market,” he said. He also noted that not all of these stocks need to fall sharply, but the case for them to keep rising is getting more difficult to make.

“I don’t think you’re going to see a coordinated downturn across every part of the economy at the same time,” Orton said. “Economic data has continued to paint a mixed picture, but it certainly doesn’t point to a sharp or imminent recession.” In his view, he doesn’t see how an official recession would play out before the first half of 2024 at the earliest, if it occurs at all.

Accumulated excess savings haven't been fully drawn down

Source: Bureau of Economic Analysis, Bloomberg. As of 3/31/2023

Not FDIC Insured | May Lose Value | No Bank Guarantee The Federal Reserve Bank of San Francisco’s economic letter from earlier this month, “The Rise and Fall of Pandemic Excess Savings,” asserted that a large stock of aggregate excess savings – around $500 billion – remains in the U.S. economy. Orton noted that the San Francisco Fed’s conclusion supported the ongoing strength that has been seen in consumer spending. “The American consumer has defied expectations,” he said.

Orton explained that real-time money-center bank data shows the distribution and allocation of excess savings and wealth suggest that households on average, including those at the lower end of the income distribution, continue to have a considerably larger amount of liquid funds at their disposal than they did during the pre-pandemic period.

What to watch

Next week will be busy for central bank watchers, with the latest release of the U.S. Federal Open Market Committee (FOMC) minutes and Personal Consumption Expenditure inflation figures. On Friday, Fed Chair Jerome Powell said the divergence between market pricing and Fed statements is often led by different forecasts; the Fed’s view that inflation would take longer to dissipate than Wall Street expectations has so far proven to be correct. Several Federal Reserve board members are also on the speech circuit this week, and investors will keep a close eye on the U.S. debt ceiling showdown.

Monday	Eurozone Consumer Confidence Indicator; au Jibun Bank Japan Manufacturing Purchasing Managers’ Index, (PMI)^®
Tuesday	Federal Reserve Bank of Philadelphia Nonmanufacturing Business Outlook Survey; Richmond Manufacturing Index; U.S. Census New Residential Sales; ECB Current Account; S&P Global / CIPS Flash United Kingdom PMI^®
Wednesday	U.S. FOMC Meeting Minutes; Mortgage Bankers Association Weekly Applications; U.K. Consumer Price Index (CPI)
Thursday	U.S. Initial Jobless Claims; U.S. Gross Domestic Product, First Quarter; Chicago Fed National Activity Index
Friday	U.S. Personal Income and Outlays; Implicit Price Deflator for Personal Consumption Expenditures; U.S. Census Bureau Retailers Inventories, Monthly Wholesale Trade Report; University of Michigan Index of Consumer Sentiment

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

Diversification does not ensure a profit or guarantee against loss.

RJIM23-0299 Exp. 9/22/2023

May 15, 2023: Summer of Discontent?

The idiosyncratic market movements of earnings season are largely over, and Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, expects an increased focus on macroeconomic data until the June meeting of the Federal Open Market Committee. “Both bulls and bears can expect to be disappointed in a summer of discontent,” Orton said.

Orton believes that volatility will keep markets moving sideways, fluctuating within a given range for an extended period of time, unless upcoming economic data breaks clearly in one direction or the other. He noted that the first sub-5% U.S. Consumer Price Index (CPI) reading and the smallest U.S. Producer Price Index (PPI) advance in two years should have been great news for the market. “Instead, investors were rattled by resurgent angst about regional banks, continued unease about the debt ceiling standoff, and a six-month low in consumer sentiment,” he said.

The S&P 500 ended the week down -0.3%, which is its sixth week in a row of moving less than 1% in either direction. Orton pointed out that key economic data points have suggested a “soft landing” — where a cyclical slowdown in economic performance falls short of becoming an actual recession — could be possible. However, he noted that the continued underperformance of regional banks is concerning, especially in light of recent University of Michigan Index of Consumer Sentiment data.

Consumer sentiment tumbles amid debt ceiling and banking uncertainty

Source: University of Michigan, Bloomberg. As of 5/12/2023

“With an economy that is slowing, and inflation that remains sticky, sinking consumer sentiment is always dangerous for spending,” Orton said. Inflation expectations have jumped to the highest level in more than a decade, which makes the backdrop even more challenging. Overall, Orton continues to advocate for more defensive positioning, leaning into quality and not chasing the market higher.

On Friday, lower-than-anticipated consumer sentiment and higherthan- estimated inflation expectations raised concerns around the viability of a soft landing. Consumer sentiment is currently at its lowest level since November, but Orton thinks that it does not directly reflect concerns around the economy. Instead, he believes that it shows the impact of growing uncertainty amid debt ceiling negotiations and continued unease regarding the banking sector. Although April’s employment figures were resilient, Orton pointed out that there has been a continued upward trend in initial jobless claims. Employers have been planning to eliminate increasing numbers of jobs, which could be a drag on confidence, and Orton said that these developments would be concerning due to their implications for falling consumption.

Spiking long-term inflation expectations further highlight that rate cuts are unlikely

Source: University of Michigan, Bloomberg. As of 5/12/2023

Orton also highlighted that long-term inflation expectations jumped to a new high for the interest-rate cycle, marking their highest level since March 2011. He believes that markets are mispricing the idea of rate cuts later this year, and the normalization of rate cut expectations remains a risk going forward. It’s another reason why Orton prefers to remain defensive in the short term.

Orton believes that the secondary effects of regional bank failures have provided some insights into the ultimate direction of the market and the economy. “The overall equity market has largely focused on good news,” he said. The S&P Banks Select Industry Index is down 32% since the beginning of March, and regional banks are down more than 40%, but the S&P 500 is up almost 5%.

“I suspect that part of the good news is also a positive reaction to a lower peak federal funds rate, which provides a tailwind to the rally of higher-duration equities,” Orton said. However, he also warned that other economically sensitive sectors — such as industrials, materials, and energy — have underperformed over the same period. “It would be foolish to ignore this growing disconnect,” he said, “but that doesn’t mean there aren’t parts of the market that look attractive and can play defense.”

Investors were rattled by resurgent angst about regional banks, continued unease about the debt ceiling standoff, and a six-month low in consumer sentiment.

Over the last month, the sectors most correlated with bank performance have been broader financials, such as financial services and insurance, and industrial cyclicals, including construction and chemicals. Orton said that he prefers the beverages and food producers industries within consumer staples, as well as the healthcare sector, which he sees as the most insulated from any potential fallout. The beverages sector has been the only sector negatively correlated to bank moves over the last month.

Orton pointed out that elevated levels of investor pessimism and washed-out equity positioning can provide ballast to the market. ETFs have seen more than $40 billion in year-to-date outflows, and money market fund assets have ballooned to more than $5.3 trillion. The Bank of America Merrill Lynch Fund Manager Survey found that institutional equity positioning has also hit a multi-year low.

“I certainly agree that negative positioning will likely help put a floor in the market, but I’m not convinced it can lead to a sustainable rally unless the fundamentals follow,” Orton said. Although he finds it supportive that the market continues to trade in a range, he is skeptical that Nasdaq gains of 20% or more have much more room to run. “If money is to come back into the market, I doubt it will continue to chase the biggest winners,” he said. Instead, Orton suspects that cash would move into areas like energy, healthcare, and dividend paying stocks that offer solid long-term growth opportunities despite their current lagging performance.

Orton said that sub-components providing the best high-quality investment opportunities are showing strength in free cash flow generation, consistency in analyst outlook, and stability of earnings per share growth. He also noted that the price volatility of a company’s stock has been closely related to its quality, which makes low volatility another attractive characteristic.

“Many of the companies globally that fit into high quality, low volatility are concentrated in healthcare, food and beverage, and subsets of industrials, like aerospace and defense within the United States,” Orton said. He explained that although the tech sector currently has strong momentum — and its quality is improving — not many tech companies screen at the top of both factors. “If we are at an earnings inflection, which I’m not sure we are, then I would expect to see more names in software and semiconductors screen as high quality, and there should be durability to their upside,” he explained.

Orton is wary of investments in the financial sector, because they do not make an appearance in quality screens either in the United States or globally. “It is too early to look to bottom fish in the sector, especially banks,” he said. Orton believes that there are plenty of attractively valued opportunities elsewhere.

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

Diversification does not ensure a profit or guarantee against loss.

RJIM23-0290 Exp. 9/15/2023

May 8, 2023: A strong market, until you peel the onion

The market managed to get through a busy week of earnings, a critical U.S. Federal Reserve (Fed) meeting, and a stronger than expected jobs report relatively unscathed. Or at least that’s how it appeared on the surface. For the week, the S&P 500 Index was down a marginal -0.8% while the Nasdaq Composite Index was up 0.1%.

The market of stocks, however, didn’t fare as well, and that’s cause for concern, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“Overall, there are definitely reasons to remain more risk-averse,” he said. “Even though at the surface, this might seem like a very strong market, all you have to do is peel back one or two layers of the onion, and there are many challenges. You’re not seeing strength across the whole market. It’s very much concentrated in the largest names. That is unlikely to continue in perpetuity, especially when you have some economic headwinds and a reckoning with higher-for-longer rates.”

The incredible narrowness of this market concerns me as does the market’s insistence to price in multiple rate cuts through the end of the year.

Last week the S&P 500® Equal Weight Index was down -1.43%. Information technology was the only sector that really worked, and even within that sector it was really all about a big post-earnings jump for one giant cell phone and computer company. Regional banks were pummeled anew and energy companies took a beating with crude prices moving sharply lower.

“The incredible narrowness of this market concerns me as does the market’s insistence to price in multiple rate cuts through the end of the year,” Orton said. This doesn’t fit with Fed Chair Jerome Powell’s clear message on Wednesday that rates are likely to remain higher for longer, and it also doesn’t fit with recent hard and soft economic data. Earnings have been better than feared. Guidance — particularly from consumer companies — highlights some challenges but also provides additional evidence that the economy is not imminently falling into recession. But some meaningful risks remain, and Orton said he continues to advocate for remaining more defensive in positioning and leaning into quality. The turmoil across regional banks and the impending debt ceiling standoff are two additional reasons not to chase the market higher.

“The Fed meeting last week likely signaled the end of the rate-hiking cycle, but it’s important to point out that a pause doesn’t mean a pivot,” Orton said. While strains on the regional banks will undoubtedly weigh on lending standards and credit conditions going forward, he said we’re not seeing data too negatively impacted right now. The Fed’s weekly report on the assets and liabilities of commercial banks in the United States has actually shown balance sheets expanding, not contracting, with consumer and real estate loans holding up while commercial and industrial loans have fallen. That said, Orton said this week’s Senior Loan Officer Opinion Survey (SLOOS) is likely to show a further tightening of lending standards in the first quarter, and it’s unclear when that tightening will come to an end. The deterioration already seen in the credit cycle would usually be enough to start driving the unemployment rate higher, and at the very least, this raises downside risks heading in the second half of 2023. But that also doesn’t mean a rapid deterioration. Friday’s jobs and non-farm payrolls report in totality also showed that while the labor market might be slowing, it remains tight and certainly tighter than many economists have expected. That provides a ballast to the American consumer. However, the front end of the yield curve is still pricing in more than 75 basis points (bps) of rate cuts by the end of the year.

Payroll growth is slowing, but not contracting

Source: Bloomberg, U.S. Bureau of Labor Statistics, as of 4/30/23

“I believe it would take a material deterioration in economic data for the Fed to cut rates, and I do not believe we’ll see any cuts this year,” Orton said. But normalization could take some time if regional banks remain in the spotlight, and markets continue to challenge the Fed’s resolve as we saw with a large front-end rally last week as concerns about yet another regional bank with a plunging share price permeated all parts of the market.

The Fed likely signaled the end of the rate-hiking cycle, but a pause doesn’t mean a pivot.

In equities, Orton said strong earnings by mega-cap tech have driven the S&P 500 to rich valuation levels that he finds inconsistent with the growth outlook going forward. The concentration at the top continues to get more extreme, with just the top 10 stocks now contributing nearly 100% of the year-to-date gains of the S&P 500. He said he remains defensive and continues to advocate for leaning into high-quality, profitable companies with earnings stability and strong free cash flow generation. Orton said he also favors tactically leaning into larger companies, while keeping a close eye for some bottoming behavior in relative small-cap performance. While the mega-cap tech leaders refuse to go down, he said would certainly not chase them higher. Healthcare continues to exhibit strong earnings and revenue growth trends and last week it led new relative highs/lows globally. He said he still likes large-cap healthcare, particularly health maintenance organizations and pharmaceuticals, which had strong results last week. The advent of artificial intelligence also merits a close look at healthcare tech companies and how they can incorporate the technology to cut costs, accelerate research, and improve patient outcomes, he said. This might be a better place to play the theme rather than directly through many of the information technology names that have already rallied sharply. Orton said he also would watch for some technical turnarounds at the industrylevel within industrials. He said he still likes the fundamental trends for aerospace and defense, and last week there was some positive technical action in machinery and electrical equipment. The outlook for capital expenditure (capex) also is stronger than expected: First-quarter capital expenditures are tracking +12% year over year (down just slightly from +18% in the fourth quarter of 2022). Despite some understandable concerns around the sustainability of earnings, Orton said capex has the potential to exceed expectations after a decade of underinvestment aided by deglobalization and re-shoring trends. Industrials could certainly be a beneficiary of this.

International developed equities have also been quite resilient with the MSCI EAFE^® (Net) Index trading at the highest level in more than a year and continuing to outperform relative to the S&P 500. Earnings results in Europe have also been quite strong with more than 70% of the STOXX^® Europe 600 (by market cap) having reported and a majority beating estimates on the top and bottom lines. The more surprising element has been the strength in profit margins. Orton said he estimates that companies in the STOXX Europe 600 on a weighted average have produced 180 bps more earnings before interest and taxes margins than consensus estimates expected. In turn, the one-year earnings per share (EPS) upgrades are creeping up (+70 bps now in the past three weeks with autos, banks, and industrials leading the way). Orton said he believes there are still some attractive opportunities in the space. He said he also believes that Japan deserves more attention as a potential outperformer going forward. Emerging markets also offer select opportunities. Orton said he most prefers leaning into Asia-ex China, though he said he has been encouraged by the recent basing in Chinese equities. Weakness in the U.S. dollar also benefits the emerging markets complex. He said he has tactically favored India recently and believes that recent strength there can continue.

Earnings have been better than feared

After another busy week of earnings, results continued to come in better than expected. With 85% of S&P 500 companies reporting results, 79% of companies have reported a positive EPS surprise with a blended earnings decline of -2.2% versus the -6.7% consensus expectation as of March 31. Critically, Orton said, we’re not seeing profit margins roll over yet. The blended net profit margin for the S&P 500 now stands at 11.5% compared with the previous quarter’s margin of 11.3%. He said he does have concerns that we may see more of a deterioration in margins should economic growth continue to slow as cost-cutting measures have largely played out. Information technology and real estate have the two strongest profit margins that could be at risk due where we are in the cycle and because of commercial real estate challenges for real estate in particular. On the flip side, revenue growth continues to slow and now stands at just 3.9%, which would be the lowest revenue growth rate reported by the index since the 3.2% in the fourth quarter of 2020. Healthcare has led the way with respect to revenue growth, and EPS results also have continued to come in pretty strong. Underperformance year to date despite strong fundamentals and defensive characteristics are two of the reasons why Orton said he would favor an overweight to the sector now.

What to watch

This week the April Consumer Price Index (CPI) report on Wednesday will take center stage. Orton said he does not expect much relief on the inflation front and wouldn’t be surprised to see a slight upside surprise, but as usual, the devil will be in the details. What will be critical, he said, is whether we see moderation in the non-housing services inflation component of the index. Earnings season also continues with important updates from companies that can provide additional clarity into the spending trajectory of the American consumer.

This week's data releases

Monday	Japan household spending
Tuesday	U.S. National Federation of Independent Business Small Business Optimism Index
Wednesday	U.S. CPI, real average earnings, and Mortgage Bankers Association Weekly Applications; Japan bank lending and foreign buying; China CPI and Industrial Sector Producer Price Index
Thursday	U.S. Producer Price Index and initial jobless claims
Friday	U.S. Import and Export Price Indexes and University of Michigan Index of Consumer Sentiment; U.K. gross domestic product, industrial production, index of services, and Bank of England 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 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.

Definitions:
The U.S. Bureau of Labor Statistics (BLS) payroll report, known as the Employment Situation Summary, is a monthly report tracking non-farm payroll employment and the national unemployment rate, with data on job trends in public and private sectors of employment. The report is based on surveys of households and employers.

Defensive stocks provide consistent dividends and stable earnings regardless of 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.

The U.S. Federal Reserve’s report on the Assets and Liabilities of Commercial Banks in the United States, known as the H8 report, is released weekly on Friday and tracks weekly increases and decreases in bank assets and liabilities across a wide range of categories of loans and deposits.

The U.S. Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices is a survey of up to 80 large domestic banks and 24 U.S. branches and agencies of foreign banks. The Federal Reserve generally conducts the survey quarterly, timing it so that results are available for the January/February, April/May, August, and October/November meetings of the Federal Open Market Committee. The Federal Reserve occasionally conducts one or two additional surveys during the year. Questions cover changes in the standards and terms of the banks’ lending and the state of business and household demand for loans. The survey often includes questions on one or two other topics of current interest.

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity.

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 moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price.

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 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.

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.

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.

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

A blended net profit margin combines actual net profit margins from companies that have reported earnings and estimated margins for companies that have yet to report.

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.

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 services inflation excluding shelter, sometimes called “super core” inflation, is a version of core inflation that excludes prices for food, energy, and housing. Core inflation includes a measure of housing services, which is what households pay for rent or the equivalent for those who own their homes.

The National Federation of Independent Business 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.

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.

Real earnings, also known as real income or real wages, reflect how much money an individual or entity makes after accounting for inflation. Unlike nominal earnings, which are not adjusted for inflation, real earnings better reflect the earner’s actual purchasing power.

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.

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

The U.S. Import and Export Price Indexes measure the changes in prices of imported goods and services purchased from abroad by U.S. companies and businesses and exported goods and services sold to foreign buyers. The indexes cover prices of non-military goods and services and are published by the U.S. Bureau of Labor Statistics’ International Price Program.

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 U.K. Index of Services, released monthly by the U.K. Statistics Authority, tracks movements in the volume of output for services industries in the U.K. using seasonally adjusted figures.

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 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.

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

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 STOXX^® Europe 600 Index represents 600 large-, mid- and small-capitalization companies across 17 European countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

RJIM23-0264 Exp. 9/8/2023

May 1, 2023: Show me the recession...

The extremes of optimism and pessimism are inadequate for current market conditions. While optimists must recognize that only a handful of companies are driving the returns in their respective indexes, pessimists need to admit that some of the worst-case scenarios are looking increasingly unlikely.

Against this backdrop, Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, maintains a wary optimism. He recommends focusing on specific investments instead of putting broad faith in the overall market. “Not everything is working in the market, and that’s what makes me a little more defensive,” he said.

U.S. equities ended the busiest week of earnings season in the green, and solid results from the mega caps boosted tech to keep a concentrated rally going. Positive results from a wide variety of companies helped to assuage fears of imminent recession, and the results broadly highlighted that American consumers are keeping their wallets open for the time being.

Although energy remains the second-worst performing sector in the S&P 500 year-to-date, some of the largest oil companies reported their strongest results since oil was $145 per barrel. “Clearly, the earnings apocalypse is not here,” Orton said. “Those calls for sub-$200 S&P 500 earnings in 2023 are just too pessimistic.”

However, Orton remains cautious. “Earnings haven’t been uniformly positive, and we cannot expect the positive results and guidance reported by the largest companies to apply to their broader sectors or industries,” he said. Orton also noted that valuations have been creeping higher. “The market trading at 19x forward earnings doesn’t look particularly compelling for adding much risk, especially given my expectation that rates will remain higher for longer.”

Not everything is working in the market, and that’s what makes me a little more defensive

Ultimately, the U.S. Federal Reserve (Fed) is the most critical reason for caution, Orton said. Indicators ahead of the Federal Open Market Committee meeting suggest that inflation is not convincingly on track toward 2%, and weaker activity remains partly a forecast, not a foregone conclusion. Orton said he fully expects the Fed to hike interest rates by 25 basis points this week, and it could keep its options open for additional tightening. Although deteriorating economic conditions would undermine the Fed’s efforts, it seems likely that Fed Chairman Jerome Powell will push back against the market pricing in multiple rate cuts this year. This is a risk for equities and an increased risk for higher-duration equities that have led market gains in a very concentrated rally.

Resilience in the face of multiple anomalies is a key reason why Orton advocates for investors to remain in the market, albeit more defensively positioned. Economic data has been decidedly mixed, and recent releases continue to highlight a tight labor market with wage gains that have broadly enabled consumers to keep spending. Even a downside surprise in the first quarter’s gross domestic product — 1.1%, compared to the consensus estimate of 1.9% — needs to be qualified by the -2.3% contribution from inventories, which remained little-changed for the quarter after their strong rise in the fourth quarter of last year. That nearly offset stronger than expected growth in personal consumption, which is a sign of strong demand when taken at face value. Final sales to domestic purchasers, or gross domestic product excluding inventories and net trade balances, jumped from 0.7% to 3.2%.

The unwinding of some very negative sentiment — and the impact of low realized volatility forcing volatility-control funds to buy stocks — provided ballast to the overall market. However, investors cannot and should not count on these forces to continue. Despite the market’s strong year-to-date gains, warning signs lurk beneath the surface.

Eight of the 11 S&P sectors are up less than 2% since their market close on Jan. 6, and more than half of them are in negative territory. This has also been the narrowest market since the 1990s: only about 30% of stocks in the S&P 500 are outperforming the index. The five top-performing stocks have delivered 60% of the year-to-date index return. Despite strong April gains across the mega-cap stocks, the rest of their sectors did not perform well. Consumer discretionary and information technology were among the month’s worst-performing sectors, which is why Orton emphasizes that recent, high-profile earnings beats are idiosyncratic; he warns against extrapolating their strength to broader industry groups or sectors.

S&P 500 sector returns (April)
S&P 500 Sector Returns for April 2023

Source: Bloomberg, as of 4/28/23

S&P 500 sector returns year to date

Source: Bloomberg, as of 4/28/23

In Orton’s view, current market conditions call for a core defensive bias that leans into quality and low-beta investments instead of chasing the market higher. There is a very real risk that the market has mispriced rate cuts in the second half of this year, he said, and last week’s economic data all but solidified a 25-basis point hike. The Fed has also been consistent in its messaging around the path of rate hikes, asserting that rates will remain higher for longer. Orton, who expects Powell to push this message home on Wednesday, said he doesn’t believe it makes sense to pile into higher-duration equities that are at the greatest risk of correction, especially because earnings still haven’t bottomed.

Drama surrounding the U.S. debt ceiling is another source of concern, and it is likely to increase as we move into the summer and approach the point where the government has exhausted its extraordinary borrowing measures. This is another reason why Orton favors quality, profitable companies that generate free cash flow and have stable earnings growth.

Orton was reluctant to say that mega-cap companies were currently synonymous with quality, largely due to the prior year of earnings volatility, some lingering uncertainty regarding their earnings cycles, and the risks around the Fed. Instead, he prefers large cap healthcare companies, particularly health maintenance organizations (HMOs) and pharmaceutical firms.

Healthcare has made strong contributions to earnings-per-share strength in S&P 500 companies, and 90% of healthcare companies have reported revenue beats. The advent of artificial intelligence (AI) should also have investors asking how healthcare tech companies can incorporate new technology to cut costs, accelerate research, and improve patient outcomes, Orton said. Healthcare companies may be a better fit for this investment thesis; IT companies have already rallied sharply.

Orton also said he believes that there are some good opportunities in overseas investments, although selectivity will be critical in developed international markets and their emerging market counterparts. Broadly speaking, international valuations are 30% cheaper than those of U.S. equities, and the divergence in performance across some key economic bellwethers is worth noting. China reopened more swiftly than many had expected, which supported not only domestic growth, but also growth in countries strongly tied to it.

Economic data outside of the United States — from Europe to Australia — continues to remain supportive, and Orton expects a reallocation of capital flows toward the rest of the world. He said he most prefers leaning into Asia-ex China, although he is encouraged by the recent basing in Chinese equities. However, he said he doesn’t favor the concentration in mega caps in China and it’s unclear whether the fundamentals have improved enough to warrant a new upswing. In international developed markets, he said he believes that healthcare and industrials look attractive as well as luxury goods companies within the consumer discretionary category.

Let’s talk about the 60/40

Orton argued that the current focus on a 60/40 portfolio — 60% equities and 40% bonds — is the wrong framing. Instead, he prefers to think of “dynamic” portfolio construction in comparison to a “static” 60/40 portfolio. “Last year was undeniably terrible for both bonds and equities,” Orton said, “and it’s no surprise that traditional static diversification did not hold up well.” That’s not the same as saying that diversification didn’t work, and it certainly doesn’t mean that it’s dead.

In Orton’s view, the new regime of higher macroeconomic volatility requires dynamic portfolio construction: It’s not enough to maintain a static allocation and hope that historical correlations will continue into the future. The decade-plus experiments with zero interest-rate policies are rapidly unwinding all around the world, and markets are still dealing with the lingering impacts of shutting down an entire global economy in response to the COVID-19 pandemic. These events put historical relationships to the test, but Orton warned that there are costs to staying static in the present. “Flexibility and dynamism are critical for this new market regime,” he said. “Ultimately, it’s a very exciting environment for finding market opportunities.”

Orton pointed out that if everything keeps going right in the short term, the broad equity upside looks comparable to bond returns that can be found in the current environment without taking too much duration or credit risk. “We can no longer set it and forget it,” Orton said. “If you expect more, let’s see how being dynamic and leaning into stock selection can get us there.”

What to watch

The Federal Reserve will be in the spotlight this week with its policymaking committee meeting on Tuesday and Wednesday. We’ll also get updates on construction spending, factory orders, jobless claims, and the April jobs report on Friday. All of this data, coupled with the FOMC meeting, should lead to another volatile week for Treasury yields. It’s also another busy week for earnings across sectors.

Monday	S&P Global U.S. Manufacturing Purchasing Managers Index^™ (PMI), U.S. construction spending, Institute for Supply Management Services^® (ISM) Report on Business® Manufacturing PMI
Tuesday	Tuesday: U.S. Job Openings and Labor Turnover Survey, factory orders, durable goods; Eurozone Consumer Price Index (CPI); Germany retail sales; Brazil trade balance
Wednesday	U.S. Mortgage Bankers Association (MBA) Weekly Applications Survey; The Services ISM^® Report on Business, FOMC rate decision; China Caixin General Services PMI; China Caixin General Manufacturing PMI
Thursday	U.S. initial jobless claims, continuing claims; Eurozone Producer Price Index (PPI); Germany trade balance; S&P Global Brazil Composite PMI^® Output Index
Friday	U.S. Bureau of Labor Statistics (BLS) payroll report, average hourly earnings; Eurozone retail sales; France industrial production

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.

Definitions:
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.

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.

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.

Gross Domestic Product (GDP) is the total value of goods and services provided in a country during one year.

Volatility control funds aim to target or limit the volatility of portfolio returns over time by adjusting their exposure according to near-term volatility forecasts.

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.

Defensive stocks provide consistent dividends and stable earnings regardless of 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.

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

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%.

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.

Correlation is a statistic that measures the degree to which two securities move in relation to each other.

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

The S&P Global U.S. Manufacturing Managers Index^™ (PMI), is compiled by S&P Global from responses to questionnaires sent to purchasing managers at a panel of about 800 manufacturers. The panel is stratified by detailed sector and company workforce size, based on contributions to gross domestic product. The questions cover business conditions, which includes individual measures of business output, new orders, employment, costs, selling prices, exports, purchasing activity, supplier performance, backlogs of orders, and inventories of both inputs and finished goods. The S&P Global U.S. Manufacturing PMI^™ focuses on the service sector of the economy but does not ask questions, such as those related to inventory levels, that pertain to manufacturing companies.

The Institute for Supply Management Services^® (ISM) Report on Business® Manufacturing PMI is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms.

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 Eurozone Consumer Price Index (CPI) measures the change in the price of goods and services from the perspective of consumers in the Eurozone, identifying changes in inflation and purchasing trends.

The U.S. Mortgage Bankers Association (MBA) Weekly Applications Survey 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 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 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 Caixin China General Manufacturing 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 Eurozone Producer Price Index (PPI) measures the average change over time in the selling prices received by Eurozone producers for their output.

The S&P Global Brazil Composite PMI^® Output Index is a weighted average of the Manufacturing Output Index and the Services Business Activity Index. The weights reflect the relative size of the manufacturing and service sectors according to official GDP data. The Composite Output Index is not comparable with the headline manufacturing PMI figure.

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

RJIM23-0256 Exp. 9/1/2023