Markets in Focus

Timely analysis of market moves and sectors of opportunity

Dec. 19, 2022: Another Fed wakeup call. Another ‘meh’ response.

The biggest macroeconomic drivers for 2022 are now past with the U.S. Federal Reserve (Fed), European Central Bank, and the Bank of England all downshifting from 75- to 50-basis point (bp) moves in their benchmark interest rates, but without, in the Fed’s case, backing away from a higher-for-longer stance.

For most of the year, the major central banks have been unified around guarding against the risks of inflation becoming entrenched and have hiked rates into restrictive territory. But as the risks of overtightening become material, we’re now starting to see dispersion in the path forward between regions, reflecting very different underlying economies and drivers of inflation, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. The Fed landed between the other two central banks with the Federal Open Market Committee (FOMC) broadly seeing terminal rate expectations higher and Fed Chairman Jerome Powell making a point to highlight that 17 of the 19 dots in the FOMC “dot plot” put the terminal federal funds rate at 5% or above. Orton has said for a while that it wouldn’t be surprising to see the terminal rate get to 5.25%, and he noted that Powell has been remarkably consistent in saying that rates need to be higher for longer.

“I expected that the European Central Bank and Fed meetings would serve as yet another wakeup call to investors who have been too optimistic in pricing a full central bank pivot,” Orton said, “but I still don’t think that everyone has received the message.”

To the contrary, Orton said it was quite remarkable how little rate pricing shifted after the Fed’s announcement: looking at prices for futures contracts before and after the FOMC decision, he said one likely wouldn’t know that there was a policy announcement in between, particularly one with a fresh set of hawkish projections.

“Clearly the market is rejecting the Fed’s forward guidance and is convinced that economic growth is slowing considerably and that the Fed isn’t going to finish the hiking process,” he said. The deeply inverted yield curve is perhaps the most pronounced example of this and there is scope for this inversion to continue. Having a 10-year Treasury note yield below 3.5% makes sense considering that the Fed’s gross domestic product (GDP) forecast at the December meeting was quite negative, worse than many prior recessions, but Orton said the front-end looks mispriced given a larger than expected terminal median dot (5.25% for the upper-bound) and only 100 bps of cuts projected for 2024 (versus the 135 bps of cuts that have been priced in overnight index swaps). “What’s clear to me, he said, “is that the clash between the peak inflation narrative and slowing economic growth will continue to play out well into 2023.”

“We’re really at this point where the market narrative is splitting in two,” Orton said. “The narrative has been dominated by inflation up to this point, and now economic realities are starting to set in. That’s where this tug of war is happening.”

Quote
Clearly, the market thinks the Fed cycle is over. I wouldn’t be so sure.


Risk assets haven’t been very constructive lately, though Orton said the weakness on Thursday and Friday shouldn’t at all be surprising. Thursday was particularly weak: The S&P 500 Index had its largest down move since early November (-2.5%), with 94% of stocks down on the day. Given that central banks were more hawkish than many of the “peak inflation” narrative bulls may have expected, he said some of the price action was probably taking chips off the table. But poor economic data that included China activity gauges, U.S. retail sales, the Empire State Manufacturing Survey, and the Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey added to a bearish tone and highlighted that the journey to continue cutting headline inflation isn’t free. There is still quite a bit of work to be done to get inflation back to target, and Orton believes that the specter of rising rates will continue to constrain valuations. He said he expects markets to remain range-bound until investors accept a higher terminal rate and we have a sense of how long rates will remain in restrictive territory.

Consequently, Orton said he continues to focus on remaining defensive in the near term. Not much worked over the past week, but dividend growth and growth at a reasonable price (GARP) once again provided some insulation relative to the broader market and remain his favored positioning by leaning into quality, earnings stability, and profitability. The recent price action has the S&P 500 sitting just below its 50-day moving average (DMA) and any additional downside risks a further correction, he said. Negative momentum certainly has the upper hand and the breakdown in financials — regional banks in particular — is worth following given that the sector tends to reflect the general investor outlook on the economy. But as we look further into 2023, there are plenty of reasons to be more constructive. On the equity side, Orton noted that it’s incredibly rare to have two negative years in a row, especially after the scale of losses in 2022 for the S&P 500. There are also dislocations in the pricing of smaller companies, which right now are signaling a severe recession on the scale of 2008. Within fixed income, 10-year Treasuries are having one of their worst years in modern financial market history, municipals offer significant value, and for the first time in well over a decade investors can build a balanced portfolio without needing to extend out on the financial risk spectrum.

Quote
The clash between the peak inflation narrative and slowing economic growth will continue to play out well into 2023.


“There certainly can be — and likely will be — further volatility and pain, but the risk/reward looks much better heading into 2023 than it did heading into this year,” he said.

S&P 500 Index annual returns since 1928

S&P 500 Index annual returns since 1928

* Year-to-date returns as of 12/16/22
Source: Bloomberg, as of 12/16/22

The U.S. 2/10 Curve remains incredibly inverted and oversold, Orton said. Whenever we’ve reached such levels in the past, there has been a steepening of the yield curve. However, he said he is not sure the reasons for steepening are good or a proper reflection of where we are right now. The yield curve typically steepens because the back end goes up and the front doesn’t. That’s not happening. A second reason is that the short-end declines in yield, usually a signal that the Fed cycle is over and not usually positive from a risk-asset perspective. “Clearly, the market thinks the Fed cycle is over,” Orton said. “I wouldn’t be so sure.”

U.S. 2/10 Yield Curve

U.S. 2/10 Yield Curve

Source: Bloomberg, as of 12/19/22

U.S. 2/10 Yield Curve distance from its 200-day DMA

U.S. 2/10 Yield Curve distance from its 200-day DMA

Source: Bloomberg, as of 12/19/22

It’s interesting to see that U.S. equities continue to lose ground relative to the rest of the world. Part of the initial push higher for global stocks was the massive rally in China on the reversal of its zero-COVID policy, but European equities also have been outperforming, though Orton noted that they’re coming up against some serious resistance and economic realities. He said he believes that select emerging markets look particularly interesting in 2023, but index exposure just won’t work. The same goes for the MSCI EAFE® (Net) Index. While Orton said he is fairly negative on the outlook for European equities, Japan looks much more interesting as the Bank of Japan embraces inflation and pursues policies that are starkly different from most other global central banks.

What to watch

In what is expected to be an otherwise quiet week, earnings from several big consumer-facing companies will be important to follow along with a slew of housing data reports, including existing home sales and housing starts, and the December homebuilder survey. Orton said the data will likely show housing coming down more quickly than is captured in the inflation reports, perhaps giving fuel for investors betting on that Fed pivot.

This week's data releases

Monday ifo Institute Business Climate Index for Germany
Tuesday U.S. housing starts; Japan interest rate decision; Eurozone Consumer Confidence Indicator; China loan prime rates; Canada retail sales
Wednesday U.S. existing home sales and U.S. Consumer Confidence Survey®; Canada Consumer Price Index
Thursday U.S. gross domestic product (GDP) and jobless claims; U.K. GDP; South Korea Producer Price Index
Friday U.S. consumer income, new home sales, and durable goods, plus University of Michigan Index of Consumer Sentiment; 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.

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

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

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

The U.S. Federal Reserve dot plot is a chart summarizing the Federal Open Market Committee’s (FOMC) outlook for the federal funds rate. Each dot represents the interest rate forecasted by one of the 12 members of the committee.

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

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 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. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

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

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

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.

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.

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

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

A 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. 2/10 Curve measures the difference between the rates of the 10-year U.S. Treasury bond and the 2-year Treasury note. Measured in basis points, it is watched as an indicator of where the U.S. economy is in the business cycle, as it the spread typically narrows as the economy moves through the cycle, reaches a low point and may go negative near the onset of a recession, then widens again during and after a recession.

Oversold is a term used to describe a security believed to be trading at a level below its intrinsic or fair value. 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 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 Eurozone Consumer Confidence Indicator is conducted by the Directorate General for Economic and Financial Affairs to measure consumer confidence within different sectors of the economies in the European Union and in the applicant countries.

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

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

The South Korea Producer Price Index, released monthly by the Bank of Korea, measures changes in the price of goods and services produced and transacted in the domestic market. The index is used to measure business trend indicators, deflators, and other economic developments.

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 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 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.

 

RJIM22-0174 Exp. 4/19/2023


Dec. 12, 2022: Clashing narratives keep uncertainty high

The two largest economic events remaining for 2022 hit the calendar this week. The November Consumer Price Index (CPI) report and the U.S. Federal Reserve (Fed) meeting have the potential to set the tone for last few weeks of the year. Last week markets struggled, coming off stretched momentum and overbought conditions and failed once again to hold critical resistance at the 200-day moving average (DMA). Interestingly, the weakness last week wasn’t driven by a jump higher in rates, but rather by increased concerns around growth Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management pointed out. Orton said he believes this clash between the peak inflation narrative and slowing economic growth will continue to hold equities hostage well into 2023, and is one of the key reasons why he still favors maintaining a core defensive bias.

“This year has been incredibly one-dimensional,” he said. “The market has been entirely focused on inflation. Now, we’re realizing that in addition to inflation, there’s an economic narrative that goes along with it. It has been staring us in the face as the 2s10s curve gets more and more inverted, and the question now is what does the recession that we move into look like? I don’t think it’s going to be that severe a recession.”

Orton said he wouldn’t be surprised to see some larger moves this week as these two narratives are forced to clash. Fed funds futures quickly go from pricing in 100 basis points (bps) of hikes in the first half of 2023 to pricing in 50 bps of cuts in the second half of the year and a full 200 bps of cuts in 2024, according to Bloomberg. The FOMC’s revised summary of economic projections, which includes the committee’s “dot plot,” will likely provide some pushback from the Fed on these early rate cuts and more information on what leaving a 5% (or higher) terminal rate for a longer period of time means. Clearly, it’s no surprise why options markets are pricing in big moves around the CPI and the Federal Open Market Committee (FOMC).

Percentage of new lows grows

Percentage of new lows grows

Source: Bloomberg, as of 12/9/22

Frankly, Orton said it’s about time that the markets start to think about slowing economic growth rather than being consumed fully by inflation. But he said he believes the market might be too bearish with respect to the recessionary narrative. To be sure, Fed Chairman Jerome Powell has said explicitly that the Fed has expected that a sustained period of below-trend growth and a rebalancing of the labor market would be necessary to bring wage growth down. And since the Fed can’t increase available workers, it will have to reduce the number of available jobs, which tends to happen in a recession. Regional Purchasing Managers’ Index results have also been negative, all while the yield curve sits at the most inverted levels since the early 1980s (and levels that have never been reached before without a recession).

But none of these economic headwinds represent new information; we’re just finally starting to focus on them again, Orton said. And the fact that nearly everyone is bearish makes Orton a little more confident that the market can perform well once we know the terminal rate. Positioning in the market remains incredibly bearish: The ratio of puts to calls is quite elevated; longer-dated bonds reflect bearishness on the economy; strategists across Wall Street are nearly universally bearish heading into 2023; and earnings and flows into both bond and equity funds and exchange-traded funds have been negative in four of the last five weeks. Earnings expectations also are being revised lower. The estimated earnings decline for the S&P 500 Index in the fourth quarter is now -2.5%, down from +3.7% at the end of the third quarter, according to FactSet. Calendar year 2023 earnings expectations also have been coming down and now sit at +5.5%, with essentially flat earnings per share growth in the first and second quarters.

“We certainly still need to see some downward revisions, but contrary to the current narrative, some of the work has already been done,” Orton said. “It gives me more confidence that any sharp market drawdown represents an attractive long-term entry point into the market.”

Inflation expectations likely to keep pressure on Fed

Friday’s release of the University of Michigan Index of Consumer Sentiment’s inflation expectations didn’t get a lot of attention, which was surprising given the emphasis that Powell has placed on ensuring these expectations remain anchored. Its importance was noted in the November FOMC minutes, which stated that participants discussed that elevated inflation levels “could increase the public’s longer-term expectations for inflation to a level above that consistent with the committee’s longer-run inflation objective.” After trending lower earlier this year, consumer inflation expectations have crept higher, raising the risk that expectations become unanchored and keep the Fed from declaring victory on inflation front for longer than markets expect. Even more, high frequency inflation expectation surveys produced by several different Federal Reserve Banks continue to point to elevated readings (despite movement in the right direction).

And last week we saw long-term expectations stuck at 3%, which is also the median for this year’s readings. That’s higher than this century’s median of 2.8% or the all-time median of 2.9% in the data going back to 1979. Of course, there have been similarly high readings of 3% in the past, but inflation wasn’t running as high, so the risk of it getting more ingrained into consumer psyches was lower before. Orton said he anticipates that forward guidance will project a higher terminal fed funds rate compared to September estimates. Powell will likely emphasize the likelihood of holding rates at restrictive levels over a longer time horizon — and possibly even challenging current market pricing of cuts in the second half of 2023.

Elevated inflation views support
higher for longer interest rates


Elevated inflation views support higher for longer interest rates

Source: Bloomberg, as of 12/9/22

What to watch

It’s all about central banks this week with the Fed on Wednesday and a host of other central bank decisions on Thursday. A 50-bp hike by the Fed is universally expected, but it’s the path forward where tremendous uncertainty remains. The summary of economic projections and the dot plot will be scrutinized and could push back against market pricing.

This week's data releases

Monday Japan Producer Price Index; U.K. and Mexico industrial output; India consumer price index
Tuesday U.S. CPI; Germany consumer price index and ZEW Financial Market Survey; U.K. unemployment and financial-stability report; Japan industrial output; Australia consumer confidence and household spending
Wednesday U.S. Fed interest rate decision; U.K. and South Africa consumer price index; Eurozone and Japan industrial output; Japan machinery orders
Thursday Interest rate decisions from the Eurozone, U.K., Mexico, and Taiwan; China property prices, retail sales, industrial output, and surveyed jobless rate; France, Israel, and Argentina consumer price indexes; Canada existing home sales, housing starts; Australia unemployment, inflation expectations
Friday Eurozone and Italy consumer price indexes

 

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 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.

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

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

A 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.

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 U.S. 2/10 Curve measures the difference between the rates of the 10-year U.S. Treasury bond and the 2-year Treasury note. Measured in basis points, it is watched as an indicator of where the U.S. economy is in the business cycle, as it the spread typically narrows as the economy moves through the cycle, reaches a low point and may go negative near the onset of a recession, then widens again during and after a recession.

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

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

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 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.

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. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on shortterm debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

Put options are financial contracts that give the buyer of the option the right, but not the obligation, to sell a specified amount of a stock, bond, commodity, or other instrument at a pre-determined price (the “strike price’) within a specified time frame. Put options increase in value as the price of the underlying asset falls, as the volatility in the price of the underlying asset increases, or as interest rates decline.

Call options are financial contracts that give the buyer of the option the right, but not the obligation, to buy a stock, bond, commodity, or other instrument — known as the underlying asset — at a specified price (the “strike price”) within a specific time period (the expiration or time to maturity). The buyer profits when the underlying asset increases in price.

An exchange traded fund (ETF) is a type of security that tracks a market index, sector, commodity, or other assets, but which can be bought or sold on a stock exchange the same way a regular stock or other security can. An ETF can be structured to track a wide variety of securities, including stocks, bonds, individual commodities, diverse aggregations of securities, and specific investment strategies.

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

The 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.S. Federal Reserve dot plot is a chart summarizing the Federal Open Market Committee’s (FOMC) outlook for the federal funds rate. Each dot represents the interest rate forecasted by one of the 12 members of the committee.

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

High frequency inflation expectation surveys are inflation estimating or forecasting tools that are based on broad sets of economic data and are produced by several different Federal Reserve Banks, such as the Inflation Nowcasts from the Federal Reserve Bank of Cleveland, the Underlying Inflation Gauge from the Federal Reserve Bank of New York, and the Underlying Inflation Dashboard from the Federal Reserve Bank of Atlanta.

The Japan Producer Price Index, released by the Bank of Japan, measures domestically produced and traded goods in the corporate sector, based on a survey of prices at the time of shipment in the producer stage.

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

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

The South Africa Consumer Price Index, released by Statistics South Africa, tracks changes in prices for a wide range of consumer goods and services in both urban and rural areas, as well as by province.

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

Israel’s consumer price index, released by the Central Bureau of Statistics, tracks changes in prices for a wide range of consumer goods and services.

Argentina’s consumer price index, the Índice de Precios al Consumidor, released by the National Institute of Statistics and Censuses, measures the price changes of a set of goods and services representative of the population’s consumption patterns within 39 urban agglomerations of all provinces of the country.

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

The 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 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 96% of the total market capitalization of all U.S. incorporated equity securities.

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.

 

RJIM22-0124 Exp. 4/12/2023


Dec. 5, 2022: Can the gains sustain?

Price action last week was once again dominated by the U.S. Federal Reserve (Fed) — or, more accurately, investors’ insistence on parsing every word in every speech from every Fed board member to try and glean some insight into the ultimate path of interest rates.

“Markets surged to end November following a confusing reaction to a speech from Fed Chairman Jerome Powell that really offered no new information,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “This has happened a number of times throughout 2022, and in nearly every case, the initial knee-jerk reaction has been wrong.”

That streak continued on Friday following better than expected jobs data that poured cold water on the dovish market reaction. Many investors continue to focus on the more dovish peak inflation narrative, but Orton said we should all be able agree that low labor force participation rates and strong wage growth are exactly the sort of things that the Fed has been worried about. Powell has put the labor market front and center in the Fed’s inflation problem, and now seeing continued negative labor supply dynamics raises the bar on the labor demand destruction required to restore balance.

Quote
While I’m very optimistic on select emerging markets in 2023, it just seems too early in the cycle for global equities to begin a new bull market.

There is no historic parallel for this environment, and Orton said perhaps that is why the price action has been so erratic on a daily and even intraday basis. While peak inflation certainly helps to build a floor for the market, Orton said he is skeptical about the sustainability of any upside breakouts, particularly with the Consumer Price Index (CPI) report and Federal Open Market Committee (FOMC) meeting looming next week. To be sure, the market is short and the year is coming to a close so we could see some upward pressure on further short covering. Cash balances are also incredibly high, and following an abysmal year, Orton said he would hazard a guess that more than a few investors will be inclined to punt on a Santa Claus rally. We need to be respectful of the price action, and he said he believes there’s a decent chance that it pushes the S&P 500 Index higher if the data continues to keep the peak inflation narrative alive. But Orton said he continues to believe this is a market to rent rather than own. Coming into this week, the market looked overbought with the 14-day relative strength index approaching 70 and 91% of S&P 500 stocks trading above their 50-day moving average (DMA). The Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, also has moved sharply lower, breaching a level of 20 for the first time since August, which has tended to result in a jump higher looking back over the past 12 months.


 

VIX has moved below 20, but that may be short-lived
VIX has moved below 20, but that may be short-lived

Source: Bloomberg, as of 12/2/22

The character of the rally in November also makes Orton wonder whether the market can reach escape velocity. Market breadth remains strong, but most recently the gains have been led by the most cyclical sectors. Materials, industrials, communication services, and financials, in particular, led the way higher last month, with gains of 11.50%, 7.57%, 6.85%, and 6.83%, respectively, versus the S&P 500’s November gain of 5.59%. Given the concerns about a slowing economy, both here in the United States and globally, Orton said it’s interesting to see these sectors as the leadership. He said it’s also interesting with rates moving lower that information technology simply performed in line with the rest of the market. The underperformance of the mega-cap complex certainly played a big role (as well as within the consumer discretionary sector), but broader performance across the sector IT outside of semiconductors wasn’t too impressive. If rates continue to drift lower, seeing improvement going forward, given the weight of the IT sector, could be cause to get more excited about the sustainability of the rally past the start of 2023, he said.

December tends to be the strongest month of the year, and a benign CPI report next week could be the catalyst for markets to take off higher into year-end, Orton said. There are certainly a number of headwinds, but while he sees risks skewed to the upside, Orton said this remains no time to chase the market higher.

Orton's key themes for 2023

Central banks certainly look to be downshifting the pace of tightening, but there is still uncertainty over the ultimate level of terminal rates, Orton said. As a result, he said there is still a risk for rates to the upside, which means it’s too early to be reaching for growth or adding too much duration. But he said he believes the first quarter of 2023 will mark a turning point with core inflation falling below terminal rates, suggesting a shift in market dynamics. Once disinflation is evident and the terminal rate is known, markets will likely redirect focus onto growth deterioration and rate cuts, leading to a resteepening of the U.S. 2/10 curve, which measures the difference between the rates of the 10-year U.S. Treasury note and the 2-year Treasury note. Additionally, Orton said he believes the focus on slower growth also could be the time for higher quality growth to outperform. For now, he said he continues to favor remaining more defensive in positioning and leaning into quality, particularly within dividend growth and growth at a reasonable price (GARP) by:

  1. Maintaining a core defensive bias. Orton said he continues to believe in sticking with what has been working: leaning into higher quality companies. Within this, dividend growth and GARP continue to outperform the broader market, and he said he expects that to continue. As he has noted recently, these higher quality, more defensive parts of the market have outperformed along with the most cyclical sector leadership. He has pointed out emerging leadership in these sectors (i.e., materials and industrials), but fundamentally he said they look a bit stretched now. He said he favors sticking with healthcare and energy, but sees new buying opportunities growing within financials.
  2. Opportunistically adding to U.S. small caps. Small caps have been underperforming the broader market over the past few weeks but remain in a solid uptrend. Valuations and underperformance in November make small caps even more attractive relative to large caps. The post-CPI bounce was historic, with more than 20% of the Russell 2000® Index jumping by more than 10%, and Orton said this tends to be positive going forward for index returns. Additionally, small caps tend to outperform in periods of extended sideways to modestly up markets, which is where he said he believes we’ll be stuck well into 2023, given the tug of war between the central bank downshift and weakening economic growth. Interestingly, the higher-quality index of small companies, the S&P 600 Index, has actually outperformed both the Russell 2000 and the broader market. Orton said this fits with his bias toward leaning into high quality. Valuations for small caps already capture more severe recessionary conditions, he said.
  3. Considering being active overseas. You may have missed the strong outperformance of global markets in November, but it’s worth highlighting. The MSCI EAFE® (Net) Index was up nearly 11.3% in November and the MSCI Emerging Markets® Index did even better, up nearly 15% (versus the S&P 500, which was up 5.6%). “While I’m very optimistic on select emerging markets in 2023, it just seems too early in the cycle for global equities to begin a new bull market,” Orton said. “If you’re going to invest overseas, it’s critical to be active to avoid value traps and to lean into the countries, sectors, and industries that can grow despite looming macroeconomic headwinds.” He said that’s particularly true for Europe, despite optically cheap valuations. The market is still very early in pricing in the earnings downgrade cycle across the Eurozone, Orton said, and that makes him wary of using valuation as the only reason to be investing. Looking at the broader STOXX® Europe 600 Index (including the U.K.), if we apply a peak-to-trough fall in earnings per share of about 33% (close to the usual recessionary fall in this region’s earnings), the 12-month forward price to earnings (P/E) ratio rises from 12x to 18x, which he said would be “not so cheap anymore.” If the peak-to-trough fall were 20%, the P/E still would rise to 15x, which would be above its long-run average of 14x. “At some point European equities will likely be an attractive recovery play,” Orton said, “but we are not there yet.”

What to watch

Global central banks will be in the spotlight with the Reserve Bank of Australia and the Bank of Canada both expected to raise rates. FOMC members are in a blackout period ahead of the Dec. 14-15 meeting.

This week's data releases

Monday U.S. factory orders, durable goods orders, Services ISM® Report on Business®; China Caixin Services Purchasing Managers Index
Tuesday U.S. trade; Japan household spending; Australia interest rate decision
Wednesday U.S. Mortgage Bankers Association weekly applications; Interest rate decisions from Brazil, Canada, and India; Gross domestic product for the Eurozone and Australia; Australia industrial output
Thursday U.S. initial jobless claims; Japan gross domestic product and balance of payments; Mexico consumer price index
Friday U.S. Producer Price Index, wholesale inventories, University of Michigan Index of Consumer Sentiment; Consumer price indices for China, Brazil and Russia; China Industrial Sector Producer Price Index, aggregate financing, and money supply

 

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Diversification does not ensure a profit or guarantee against loss.

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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.

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.

Core inflation, as measured by the “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy” is an aggregate of prices paid by urban consumers for a typical basket of goods, that does not include food and energy. Core CPI is widely used by economists because food and energy typically have very volatile prices.

Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price.

Short covering refers to buying back borrowed securities in order to close out an open short position at a profit or loss. It entails buying the same security that was initially sold short and handing back the shares initially borrowed for the short sale.

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

A relative strength index (RSI) is a momentum indicator that tracks the magnitude of recent price changes to analyze overbought or oversold conditions in the price of a particular asset. Typically, RSI values of 70 or higher indicate that an asset is becoming overbought or overvalued. RSI values of 30 or below suggest oversold or undervalued conditions.

A 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 Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.

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

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

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.

Disinflation refers to the temporary slowing of the pace of price inflation and describes what happens when the inflation rate is marginally lower over the short term. Disinflation refers only to the rate of change in the rate of inflation. In this, it is distinct from inflation and deflation, which describe the direction of prices.

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. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

The U.S. 2/10 Curve measures the difference between the rates of the 10-year U.S. Treasury bond and the 2-year Treasury note. Measured in basis points, it is watched as an indicator of where the U.S. economy is in the business cycle, as it the spread typically narrows as the economy moves through the cycle, reaches a low point and may go negative near the onset of a recession, then widens again during and after a recession.

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

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

A value trap is security that appears to be inexpensive because it has been trading at low valuation metrics, such as multiples in terms of price to earnings ratios for an extended time period. The low relative historical valuations can attract investors who see a value, but then become trapped when the security languishes or drops further after the purchase.

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.

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

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

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

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.

A balance of payments is a statement of all transactions in goods and services made between all individuals, companies, and government agencies in one country and the rest of the world over a defined period, such as a quarter or a year.

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

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

The 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 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.

Brazil’s Extended National Consumer Price Index (IPCA), calculated by the Brazilian Institute of Geography and Statistics, measures the inflation rate for selected retail products and services, including food and beverages; housing; household articles; wearing apparel; transportation; health and personal care; personal expenses; education; and communication. The index is constructed to cover 90% families living in 13 geographic zones: the metropolitan areas of Belém, Fortaleza, Recife, Salvador, Belo Horizonte, Vitória, Rio de Janeiro, São Paulo, Curitiba, Porto Alegre, as well as the Federal District and the cities of Goiânia and Campo Grande.

 

RJIM22-0149 Exp. 4/5/2023