Markets in Focus

Timely analysis of market moves and sectors of opportunity

August 29, 2022: What really has changed?

As expected, U.S. Federal Reserve (Fed) Chairman Jerome Powell last week pushed back against the notion of a pivot in no uncertain terms and made the case for keeping rates in restrictive territory for an extended period of time. He was not alone. Federal Reserve Bank of St. Louis President Jim Bullard reiterated his preference for continued front-loading and a 4.0% fed funds upper bound by the end of the year. Philadelphia Fed President Patrick Harker said he prefers to get rates above 3.4%, then “maybe sit a while.”

“None of this is surprising,” said Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers. “Inflation is simply too high and the economy is in good shape to withstand more restrictive rates. I believe Powell did what he had to do to finally make the message sink into the market that there is no dovish pivot coming. I’ve been saying since July that the dovish interpretation by the market was misguided.”

Nothing that Powell said changes the outlook for corporate profitability or the economy.

Further, Orton said it’s critical that long-term inflation expectations remain anchored and the Fed needed to maintain a hawkish tone to get through to investors and help accomplish this. Also as expected, we didn’t receive any clarity regarding the September rate hike. Payrolls data on Friday and U.S. Consumer Price Index data on Sept. 13 will dictate whether we see the Fed move 50 or 75 basis points. Orton said his base case expectation remains a “lower-for-longer” terminal fed funds rate that reaches less restrictive levels (3.5% by December 2022) than in previous tightening cycles, but stays there for an extended period of time (all the way through 2023).

While equity markets interpreted Powell’s message as quite hawkish, Orton said he wouldn’t read too much into the sharply negative returns on Friday. He was surprised to see the markets drifting higher in the days preceding Powell’s speech, and he said Friday’s drop simply reversed those gains and reflected a more realistic outlook that there never was a dovish pivot coming from the Fed. The market is also coming off a nearly 17.5% rally that was unchecked. At the start of the week equities were down only 5.6% from the highs on Aug. 16 and remained nearly 11% above the June 16 lows. That said, Orton believes there are some important technical levels that need to hold to keep this upside reversal alive. September is historically the weakest month of the year with average returns of -0.35% over the past 20 years.

“Given seasonal headwinds and a lack of company-specific catalysts with earnings season largely behind us, I would expect choppy conditions to persist,” he said. “But for long-term investors, that’s not necessarily a bad thing.”

Even with heightened volatility and seasonal headwinds, Orton said the overall picture for equities remains supportive from positioning, sentiment, and technical standpoints:

  • Speculative positioning is very net short, leaving the market more vulnerable to squeezes;
  • Sentiment has been improving from very bearish levels; and
  • Internals such as the advance-decline line and the net number of stocks making new 52-week highs have both been improving sharply.

“Nothing that Powell said changes the outlook for corporate profitability or the economy,” Orton said.

Still low, but improving

No surprise: S&P 500 meets resistance at the 200-day DMA

Source: Bloomberg, American Association of Individual Investors, as of 8/26/22.

At an all-time high, and suggestive

No surprise: S&P 500 meets resistance at the 200-day DMA

Source: Bloomberg, as of 8/26/22

Orton’s playbook

Powell’s hawkish comments were necessary to reset market expectations around the Fed’s fight against inflation, but Orton said they don’t change the fact that the economy is continuing to hold up relatively well. Economic data released last week was overshadowed by Jackson Hole, but it’s worth highlighting a few key points: July headline Personal Consumption Expenditures (PCE) Price Index declined, another signal that inflation is moving in the right direction; the final University of Michigan Index of Consumer Sentiment was revised up and inflation expectations were revised down; July personal spending also rose 0.1% month over month and personal income rose 0.2%.

Given seasonal headwinds and earnings season largely behind us, I would expect choppy conditions to persist.

Still, risks abound as this week brings some critical data for the September Federal Open Market Committee decision. A strong August payrolls report on Friday would keep a rate increase of 75 basis points on the table for September, but Orton said he still believes the totality of data still weighs toward a downshift to a 50-basis point increase. That’s why he said he continues to favor maintaining a core defensive bias but using downside opportunistically to add some marginal beta exposure into portfolios. His favored defensive positioning remains dividend growth, growth at a reasonable price (GARP), and healthcare, which have all outperformed year to date during market volatility (including a resumption in outperformance over the last two weeks). Increasing small-cap positioning has certainly helped keep up with the market during rallies, and Orton said he continues to like small caps and reducing underweight positioning in light of the facts that:

  • The Russell 2000® Index has rallied about 19% since equities marked their lowest close of the year on June 16, which was around when Orton started calling for a reversal. But he noted that small caps also are holding up recently during more volatile periods. The Russell 2000 outperformed all other market capitalizations last week with the Russell 2000 down -2.93%; the Russell Midcap® Index down -3.28%; the Russell 1000® Index down -3.87%, and the broad-market S&P 500 Index down -4.02%.
  • Valuations remain compelling, he said. The 12-month forward price-to-earnings (P/E) spread between the Russell 2000 and the S&P 500 is currently below the average level during market turbulence during the economic contractions of 2001, 2008, and 2020. Even if the economy weakens from here, there still seems to be scope for normalization, he said. Earnings have also been better than expected, providing another tailwind, along with increased breadth and improved internals.

What to watch

The market may be heading into holiday mode this week ahead of the Labor Day Weekend, but there are a couple of key data points, notably the August jobs report that drops at the end of the week. Other economic reports include updates on consumer confidence, construction spending, and vehicle sales. We also get earnings a few key Chinese tech companies and other companies in aerospace and electronics; cybersecurity; information technology; electronics retailing; pet supplies; software; cloud software and computing; discount retailing; semiconductors; athletic apparel; and processed food.

This week's data releases

Monday Federal Reserve Bank of Dallas Texas Manufacturing Outlook Survey
Tuesday U.S. consumer confidence; Japan jobless report; Spain and Germany CPI; U.K. house price survey; Eurozone Consumer Confidence Indictor
Wednesday U.S. ADP® National Employment Report; Eurozone, France, and Italy CPI; China Purchasing Manager Index; Japan industrial output and retail sales
Thusday U.S. initial jobless claims, construction spending, and Institute for Supply Management manufacturing Purchasing Managers’ Index; Eurozone and Italy unemployment; China Caixin Services Purchasing Managers Index
Friday U.S. factory orders, unemployment, durable goods, and nonfarm payrolls; Eurozone industrial producer price index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

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

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

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.

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%.

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.

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.

A short squeeze refers to what happens when the price of an asset rises sharply and forces short-sellers who had bet that its price would fall to buy it instead in order to avoid incurring even greater losses. In turn, those purchases put more upward pressure on the asset price.

Internals refer to quantitative market indicators that investment professionals monitor to spot trends and forecast movements within securities markets. A subset of technical indicators, internals include a number of formulas and ratios, such as the number of stocks moving in the same direction as a larger trend, the ratio of securities with rising and falling prices, the ratio of new highs to new lows, and price and volume indicators that are seen as indicators of overall market sentiment.

The advance/decline line is a technical indicator that tracks the difference between the number of advancing and declining stocks on a daily basis. It is used to track market sentiment, confirm price trends in major indexes, and highlight the possibility of that a trend in trading could be heading for a reversal. The indicator is cumulative, with a positive number being added to the prior number, or if the number is negative it is subtracted from the prior number.

The American Association of Individual Investors Sentiment Survey reflects answers offered each week by AAII members to the question: What direction do they feel the stock market will take in the next six months? Answers are sorted into bullish, neutral, and bearish categories.

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

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

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.

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

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

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

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

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

The Federal Reserve Bank of Dallas conducts the Texas Manufacturing Outlook Survey monthly to obtain a timely assessment of the state’s factory activity. Firms are asked whether output, employment, orders, prices and other indicators increased, decreased, or remained unchanged over the previous month. Responses are aggregated into balance indexes where positive values generally indicate growth while negative values generally indicate contraction.

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

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

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

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

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

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

The French Producer Price Index measures trends in transaction prices, exclusive of value-added taxes, for goods from industrial activities and sold on the French market, based on monthly price reports on some 24,000 products collected from a representative sample of 4,200 companies.

The Italian Producer Price Index, compiled by Italy’s Istituto Nazionale di Statistica, tracks industrial producer prices on a monthly basis for durable and non-durable consumer goods, capital goods, intermediate goods, and energy.

The China Purchasing Manager Index, compiled by the National Bureau of Statistics of China, is based on a monthly survey of purchasing managers in 31 divisions of manufacturing enterprise and 43 divisions of non-manufacturing enterprise.

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

The China Caixin Services Purchasing Managers Index is compiled from responses to questionnaires sent to purchasing executives in over 400 private service sector companies.

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

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The 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.

The Russell Midcap® Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities of the Russell 1000® Index based on a combination of their market capitalization and current index membership and represents approximately 27% of the total market capitalization of the Russell 1000® Index.

The Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000® Index, which represents approximately 93% of the total market capitalization of the Russell 3000® Index.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data, and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor, or endorse the content of this communication.

 

CTA22-0523 Exp. 12/29/2022


August 22, 2022: Can the summer gains hold?

The weakness at the end of last week and the start of this week is not only perfectly normal but necessary after a strong rally off of historically oversold conditions, apocalyptic sentiment, and better than feared earnings, said Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers.

“If anything, the fundamental narrative itself continues to improve,” Orton said. “The data that we saw last week continues to push back against any notion that we’re heading toward a deep recession or a recession in the near term. What I believe precipitated the downward move for the market is the fact that we’re probably not going to be cutting rates once we get into 2023 because a deep recession that’s going to need meaningful rate cuts just isn’t on the table. I believe that’s what the market is working through right now.”

The S&P 500 Index peaked at +17.4% from the June 16 lows while the Russell 2000® Index was +20.5% and the Nasdaq Composite Index was +22.5%. With momentum overbought and sentiment stretched, the market unsurprisingly ran into strong resistance at the 200-day moving average (DMA). We also heard from more U.S. Federal Reserve (Fed) speakers that the notion of a “pivot” is misguided when inflation is still running hot. Federal Reserve Bank of San Francisco President Mary Daly (a non-voter on Fed interest rate decisions) pushed in favor of raising rates above the neutral rate, which aligns with Orton’s view that Fed will raise rates up to 3.5% by the end of the year and hold them until inflation is back closer to 2%. Federal Reserve Bank of St. Louis President Jim Bullard (a voter) further supported this and mentioned that lowering interest rates is “premature.” The Federal Open Market Committee minutes also emphasized that inflation was unacceptably high and that policy makers weren’t convinced oil and gas prices would stay down. While this may have checked investor ebullience somewhat, Orton noted that initial jobless claims remain depressed and the Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey points to expansion. Both, he said, push back against the notion of an imminent recession.

Overall, the consolidation that started last week is healthy, Orton said, and it could provide an opportunity for investors to deploy capital and continue to add marginal exposure to higher beta areas of the market like small caps. Further downside from here is likely, he said, given how quickly the market jumped higher as well as twin headwinds from rising rates and a reversal in the downtrend of the dollar. The one-year forward price-to-earnings ratio has risen from 15.6 to 18.6 since the market low. Any further rebound in yields as Fed officials push back against the “pivot” will likely compress some of the froth that led the market higher, he said.

No surprise: S&P 500 meets resistance at the 200-day DMA

No surprise: S&P 500 meets resistance at the 200-day DMA

Source: Bloomberg, as of 8/19/2022.

Jackson Hole expectations

Orton said he expects the tone from Jackson Hole to echo the recent Fed minutes, signaling that rates may need to remain in restrictive territory for longer than markets expect given post-pandemic developments in the economy. Some participants indicated in the minutes that “once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2%.” Action in fixed income markets last week shows that it may take a while for investors to unwind rate-cut pricing, but that is generally a good thing for the current equity narrative. Instead, Orton said he believes the Fed will stay on hold at 3.5% and be very cautious about tightening further. This still leaves scope for the U.S. dollar to weaken, especially if we continue to receive confirmation that we’ve reached peak hawkishness.

Why so negative?

It’s worth highlighting that there is still a considerable amount of skepticism that the recent strength in equities is nothing more than a bear market bounce fueled by positioning dynamics, Orton said. To be sure, multi-decade highs in cash positioning, the lowest levels of investor sentiment, and cratering optimism around the global economy all helped the summer rally. A recent fund manager survey, however, shows cash levels still elevated and above the highs in December 2008. Inflows back to equities still have room to run, he said. August has been a very quiet month with only $3 billion goinginto equities.

What does peak inflation mean for the market?

As suspected, last week’s data on inflation confirmed that we’ve finally seen the peak inflation, Orton said. The Consumer Price Index (CPI) for July delivered the first downside surprise in nearly a year, with headline inflation flat, compared with 1.3% for the prior month. Core inflation, which excludes volatile food and energy prices, rose by 0.3% month over month compared with a rise of 0.7% for the prior month. On a year-over-year basis, headline CPI declined to from 9.1% to 8.5% while core inflation stayed at 5.9%. While some of the slowdown was a function of sharp declines in several categories — energy fell 4.6% month over month and airfares were down 7.8% — overall the details pointed to the deceleration being relatively broadly based, confirmed by the Federal Reserve Bank of Cleveland’s median and trimmed-mean CPI measures.

With recent hot wage prints, however, the inflation environment remains precarious and all of the talk of a Fed “pivot” is premature, Orton said. Fed officials are far from declaring inflation victory yet, and recent speakers have pushed against notion of 2023 cuts. Federal Reserve Bank of Chicago President Charles Evans, who doesn’t have a vote on the FOMC, described the July CPI report as the “first positive report,” but continued to characterize inflation as “unacceptably high.” Orton said he concurs and expects the Fed to raise interest rates to a terminal rate of 3.5% by the end of this year, then leaving them there through next year as inflation grinds toward — but stays above — the Fed’s 2% target. It’s worth remembering that a 75-basis point hike remains a plausible risk scenario, and the September decision will remain contingent on the next round of CPI and payroll data, both of which will be in hand before the Sept. 21 FOMC meeting.

“I don’t think there’s a Fed pivot coming,” Orton said. “Inflation is still running at more than 8% year over year. Core inflation is still at almost 6% year over year. These are big numbers and we’re not close to where I think we need to be. I think the Fed probably is looking at 50 basis points in September, 50 basis points in November, and then once we get to 3.5% I think the Fed is likely to pause and reassess.”

This is also why growth at a reasonable price (GARP) and dividend growth have been lagging somewhat during the recent rally, he said.

Still, the deceleration in inflation is certainly welcome and has provided some support to the “peak hawkishness” narrative, Orton said. Coupled with a better than feared earnings season, this has provided investors with more confidence that the economy is not spiraling into a recession, and some semblance of a softish landing is achievable. This has helped to support risk assets and has weighed on the dollar — a trend that Orton said he believes will continue with few catalysts for the rest of the month and further position-squaring as traders close out positions to eliminate market risk. This should help offset some of the foreign exchange headwinds faced by large-cap companies that we heard about during earnings season, especially in software, he said. Further dollar weakness also should provide support for emerging markets, which have been quietly outperforming over the past few weeks. Orton said he continues to like emerging markets for increasing beta exposure in global portfolios, specifically India, Latin America, and China.

“If the naysayers are expecting weakness simply because positioning dynamics have played out, I don’t think that argument holds water,” Orton said.

Further, as the third quarter started there were expectations for an earnings apocalypse that would further pressure equities as analyst estimates needed to be cut significantly. However, earnings season has been better than feared: revenue growth has exceeded 13%, marking the fifth quarter in a row of double-digit growth while margins remain above 12%. Earnings estimates have also come down, but they were not massively slashed given that guidance remained broadly neutral to optimistic. For the third and fourth quarters, analysts project earnings growth of 5.8% and 6.1%, respectively.

“This doesn’t strike me as wildly optimistic, and I think the narrative of estimates still needing more meaningful downward revisions is a bit deaf to what we’re seeing play out with respect to the economy and the consumer,” Orton said. “I remain optimistic on the market over the medium term.”

As the market digests the summer rally and move through some healthy consolidation, Orton said he believes the tailwinds from positioning dynamics will continue and additional upside can be supported as the consumer remains healthy and corporations continue to spend on capital. Core retail sales were surprisingly robust in July with healthy credit and debit card data while earnings from key retailers last week also showed strong spending trends.

Use short-term weakness for long-term gains

Consequently, Orton said his playbook remains the same: maintain a core defensive bias but continue to add beta exposure to portfolios on weakness. Higher quality has lagged on the jump higher across market capitalizations (most notably in small caps), but he said this has largely been the result of highly leveraged companies outperforming low-leverage ones, not the result of the return-on-equity (ROE) or earnings-per-share growth lagging. Orton said he would still lean into higher-quality dividend growth companies and add exposure to higher-quality small caps, which he said have meaningfully lagged over the past few weeks. Lower ROE names in the Russell 2000 now trade at 6.5x sales versus 1.2x for the highest ROE stocks. Orton said the underperformance of higher-quality stocks in small caps also shows up in the relative performance of the higher-quality S&P 600 Index versus the Russell 2000. “We’re seeing a reversal within the scope of the outperformance of quality,” he said.

Dividend Growth could resume strong relative performance

Dividend Growth could resume strong relative performance

Source: Bloomberg, as of 8/19/2022

Ratio of S&P 600 Index performance to
Russell 2000 Index performance

Ratio of S&P 600 Index performance to Russell 2000 Index performance

Source: Bloomberg, as of 8/19/2022

What to watch

The focus of the markets this week will be on Jackson Hole and the tone from Federal Reserve members at their annual symposium. With the market a bit ahead of itself, a more hawkish tone from Fed Chairman Jerome Powell could present a headwind to further gains. We also get reports on durable goods, home prices, manufacturing, and on Friday the Personal Consumption Expenditures Price Index, plus earnings from companies in business communications; cybersecurity; medical devices; e-commerce; consumer goods; information technology; software; banking and financial services; cloud data; retail; and exercise equipment and subscriptions.

This week's data releases

Tuesday U.S. new home sales; U.K. and Eurozone flash composite purchasing managers’ indices
Wednesday U.S. durable goods orders and pending home sales
Thusday Federal Reserve Jackson Hole meeting; U.S. initial jobless claims and second quarter gross domestic product; European Central Bank monetary policy account; ifo Institute Business Climate Index for Germany
Friday U.S. personal income and spending; Jackson Hole meeting; Japan Consumer Price Index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

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

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

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

The neutral rate is the theoretical federal funds rate at which the stance of U.S. Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

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

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

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

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

Core retail sales include all consumer spending except for automobiles, gasoline, building materials, and food services.

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

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

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.

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.

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

Purchasing Managers’ Index data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies. PMI data features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as gross domestic product, inflation, exports, capacity utilization, employment, and inventories.

The IHS Markit Flash Eurozone Composite PMI (Purchasing Managers’ Index) is based on about 85% of the final number of replies received each month from a survey of a representative panel of private sector firms across the countries in the European Union.

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

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

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

The Japan Consumer Price Index, released monthly by the Statistics Bureau of Japan, tracks core inflation by monitoring price changes in a wide variety of goods and services, excluding fresh foods but including energy, purchased by households nationwide.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

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

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

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 10% of the total market capitalization of the Russell 3000® Index.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data, and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor, or endorse the content of this communication.

 

CTA22-0513 Exp. 12/22/2022


August 15, 2022: A breadth of fresh air

The likelihood that the low on June 16 marks the bottom of the bear market continues to increase, said Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers. The rally from historically oversold conditions and apocalyptic investor sentiment has been strong and the S&P 500 Index decisively pushed through the prior highs around 4200 with more than 90% of stocks up volume.

“This level of breadth is a key distinguishing feature between a bear market rally and the start of a bull market,” Orton said. “Absent some massive change in U.S. Federal Reserve policy or really surprisingly bad data from somewhere else in the world I don’t think we break back through the lows that we had in June.”

This is, however, a whipsaw-prone environment and the positive tailwinds from earnings season are coming to a close, leaving investors to focus on every piece of economic data and every comment from Fed speakers until the September Federal Open Market Committee (FOMC) meeting. Momentum and sentiment are overbought, and Orton said he wouldn’t be surprised to see some consolidation in the short term.

“I believe this actually would be healthy since the rally has largely been unchecked and it would give investors who still have meaningful cash balances the opportunity to put more capital to work,” he said. “It’s okay to be less bullish here, but it’s not okay to be outright bearish. Don’t chase the market higher, but continue to use downside opportunistically.”

Nothing supports the durability of a recovery like
a 90% up-volume day. Two days are even better.

Nothing supports the durability of a recovery like a 90% up-volume day. Two days are even better.

Source: Bloomberg, as of 8/12/2022.

As markets stabilize, previous momentum winners usually underperform as momentum laggards start to emerge, Orton said. This has played out with consumer discretionary and information technology — the two worst performing sectors in the first half of 2022 — meaningfully outperforming the market since June 16, while energy is barely positive: +1.58% versus +16.73% for the S&P 500. Dividend growth and growth at a reasonable price (GARP) also have underperformed the market over the past few weeks after having outperformed through the market volatility. This is a key reason why Orton said he believes in adding beta exposure into portfolios. But “the easy money has been made,” he said, and he would be careful about extrapolating this trend too far into the future. While Orton said he still likes small caps and higher quality information technology as ways to add risk to portfolios, it continues to make sense to maintain a defensive bias given how overbought the market is now.

“Remember, we are in a bottoming process, and it’s highly unlikely we have a V-shaped rebound with the Fed still raising rates,” he said.

It’s okay to be less bullish here, but it’s not okay to be outright bearish.

What does peak inflation mean for the market?

As suspected, last week’s data on inflation confirmed that we’ve finally seen the peak inflation, Orton said. The Consumer Price Index (CPI) for July delivered the first downside surprise in nearly a year, with headline inflation flat, compared with 1.3% for the prior month. Core inflation, which excludes volatile food and energy prices, rose by 0.3% month over month compared with a rise of 0.7% for the prior month. On a year-over-year basis, headline CPI declined to from 9.1% to 8.5% while core inflation stayed at 5.9%. While some of the slowdown was a function of sharp declines in several categories — energy fell 4.6% month over month and airfares were down 7.8% — overall the details pointed to the deceleration being relatively broadly based, confirmed by the Federal Reserve Bank of Cleveland’s median and trimmed-mean CPI measures.

With recent hot wage prints, however, the inflation environment remains precarious and all of the talk of a Fed “pivot” is premature, Orton said. Fed officials are far from declaring inflation victory yet, and recent speakers have pushed against notion of 2023 cuts. Federal Reserve Bank of Chicago President Charles Evans, who doesn’t have a vote on the FOMC, described the July CPI report as the “first positive report,” but continued to characterize inflation as “unacceptably high.” Orton said he concurs and expects the Fed to raise interest rates to a terminal rate of 3.5% by the end of this year, then leaving them there through next year as inflation grinds toward — but stays above — the Fed’s 2% target. It’s worth remembering that a 75-basis point hike remains a plausible risk scenario, and the September decision will remain contingent on the next round of CPI and payroll data, both of which will be in hand before the Sept. 21 FOMC meeting.

“I don’t think there’s a Fed pivot coming,” Orton said. “Inflation is still running at more than 8% year over year. Core inflation is still at almost 6% year over year. These are big numbers and we’re not close to where I think we need to be. I think the Fed probably is looking at 50 basis points in September, 50 basis points in November, and then once we get to 3.5% I think the Fed is likely to pause and reassess.”

This is also why growth at a reasonable price (GARP) and dividend growth have been lagging somewhat during the recent rally, he said.

Still, the deceleration in inflation is certainly welcome and has provided some support to the “peak hawkishness” narrative, Orton said. Coupled with a better than feared earnings season, this has provided investors with more confidence that the economy is not spiraling into a recession, and some semblance of a softish landing is achievable. This has helped to support risk assets and has weighed on the dollar — a trend that Orton said he believes will continue with few catalysts for the rest of the month and further position-squaring as traders close out positions to eliminate market risk. This should help offset some of the foreign exchange headwinds faced by large-cap companies that we heard about during earnings season, especially in software, he said. Further dollar weakness also should provide support for emerging markets, which have been quietly outperforming over the past few weeks. Orton said he continues to like emerging markets for increasing beta exposure in global portfolios, specifically India, Latin America, and China.

We are in a bottoming process, and it’s highly unlikely
we have a V-shaped rebound with the Fed still raising rates.

Small caps: Anomalies and opportunities

The Russell 2000® Index has outperformed the S&P 500 over the past few weeks, with marked improvement in breadth. The index is approaching its 200-day daily moving average (DMA), and Orton said he expects a decisive break of this key level of resistance to push the Russell 2000 back into the range where it moved sideways for most of 2021. Not surprisingly, he said, there has been a strong rally from the bottom for the lowest quality and smallest small-cap companies that had been decimated over the previous six to eight months. Historically, he said, we tend to see this occur at the start of a rally. It happened after the uplifting COVID-19 vaccine announcement in November 2020 and continued into the first quarter of 2021. The rally in small caps has been driven by an improving economic narrative, the move lower in rates, and position-squaring by speculative investors, Orton said. These benefits have likely played out, and he said he expects that higher quality will lead the next leg higher as he believes there is no way that companies with no sales growth can continue to rally the way they have: +52.5% since June 16. Orton said he’s encouraged that we can see the outperformance of small caps continue as larger, more profitable companies take over as outperformers. Earnings season should also provide a tailwind for this: the blended earnings growth rate for the Russell 2000 is nearly 8.5%, beating the 6.7% earnings growth rate for the S&P 500.

A strong rally in small caps

A strong rally in small caps

Source: Bloomberg, as of 8/12/2022.

What to watch

Investors will get a good look at housing market trends this week with data releases on the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index, building permits, housing starts, and existing home sales. We’ll also get a look at some critical retailer earnings reports, plus earnings from companies in technology; restaurants; cosmetics; high-end consumer goods; semiconductors and software; agricultural machinery; and athletic shoes. FOMC July minutes also will be released on Wednesday.

This week's data releases

Monday U.S. Empire State Manufacturing Survey and National Association of Home Builders Housing Market Index; Japan gross domestic product; China jobless rate, retail sales, and industrial output
Tuesday U.S. housing starts, industrial output; U.K. unemployment; Germany ZEW Financial Market Survey
Wednesday U.S. retail sales, FOMC minutes
Thusday U.S. initial jobless claims, Federal Reserve Bank of Philadelphia Manufacturing Business Outlook Survey, existing home sales; Eurozone Harmonised Index of Consumer Prices
Friday U.K. retail sales; Japan Consumer Price Index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

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

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

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

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

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

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

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.

Headline readings of inflation, also known as nominal inflation, include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index. By contrast, core measures of inflation exclude food and energy prices and are used as economists and other market participants as a more reliable measure of inflation trends.

The Federal Reserve Bank of Cleveland’s median CPI measurement is the one-month inflation rate of the CPI component whose expenditure weight is in the 50th percentile of price changes.

The Federal Reserve Bank of Cleveland’s 16 percent trimmed-mean CPI is a weighted average of one-month inflation rates of components whose expenditure weights fall below the 92nd percentile and above the 8th percentile of price changes.

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%.

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

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

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

The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.

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

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

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

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

The Japan Consumer Price Index, released monthly by the Statistics Bureau of Japan, tracks core inflation by monitoring price changes in a wide variety of goods and services, excluding fresh foods but including energy, purchased by households nationwide.

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 Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 10% of the total market capitalization of the Russell 3000® Index.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data, and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor, or endorse the content of this communication.

 

CTA22-0503 Exp. 12/15/2022