“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
As the outlook for recent winners remains murky, investors appear to be rotating toward favorably priced parts of the market where growth is strong or accelerating.
Consequently, the equities market is not seeing a rising tide that lifts all boats.
Given persistent volatility around headlines and the unwinding of momentum, the playbook for Matt Orton, CFA, continues to focus on diversification across sectors, industries, market capitalizations, and geographies.
The market might be moving sideways, but there is quite a bit of healthy movement beneath the surface, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
Rotation from large-cap growth into large-cap value and mid caps is providing a ballast to the market.1 There is also movement overseas into Europe and China to a lesser degree. Despite strong earnings at the top, Orton said guidance hasn’t kept pace with expectations to justify current multiples, especially given uncertainty around the future buildout of artificial intelligence (AI).
Rather than waiting and seeing, investors seem to be moving toward favorably priced parts of the market where growth remains strong or is accelerating. That includes banks, parts of healthcare like equipment and supplies, parts of industrials, and even the broader technology complex. In fact, the Nasdaq-100 Equal Weighted Index is meaningfully outperforming both the broad market and the Nasdaq 100® Index: It is up 6.26% year to date versus the 2.42% return of the S&P 500 Index and the 2.96% return of the Nasdaq 100. The rotation also includes Europe, where earnings have meaningfully surprised to the upside and valuations have been favorable relative to U.S. equities.
“What I believe is clear is that selectivity truly matters,” Orton said. “There is no rising tide lifting all boats anymore. I believe investors who lean into better diversification across sectors, industries, market capitalizations, and geographies can do well.
“This continues to be my playbook moving forward given the persistent volatility around headlines and the unwinding of momentum,” he said. “I believe there are still plenty of opportunities as investors overreact to headlines and throw good companies out with the bathwater. I have advocated for a long time that investors should avoid chasing the market higher and instead consider using downside opportunistically. And given the noisy environment we’re in right now, I believe there will be plenty of opportunities to consider for continuing to improve portfolio diversification.”
Momentum faltering while safety factors pick up steam and smaller companies build on strength
U.S. factor returns year to date
Source: Bloomberg, as of 2/21/25. Factor returns cover all equities in the U.S. market tracked by Bloomberg within the Factors to Watch (FTW) terminal function and represent the top quintile of returns within each factor less the bottom quintile of returns.
Speaking of noise, Orton said, it’s interesting to see quite weak sentiment among traditional retail investors while institutional investors remain fairly optimistic. The American Association of Individual Investors (AAII) ratio of bulls to bears is near its lowest level in two years, which Orton believes is actually a good thing for the market.
“We’re not at peak optimism,” he said, “and the general malaise in retail sentiment is probably part of the reason that we haven’t seen a strong bid for the Magnificent Seven or the AI halo trade.”
On the flip side, institutional investors remain quite bullish, embracing the resilience of the U.S. economy as well as the recent strength across Europe. Cash levels are near their lowest levels in 15 years. These low levels of cash could certainly lead to a temporary pullback should we see some uncomfortable economic or inflation data, but Orton believes this sort of dip could be a buyable opportunity given the generally strong takeaways from earnings season, including strengthening profit margins and a continued broadening of growth. Additionally, a pullback of more than 5% might be what retail investors need to start coming back into the market.
2025 year-to-date U.S. returns style box
Source: Bloomberg, as of 2/21/25.
So how should investors think about positioning right now given the changes we’re seeing beneath the surface and the tug-of-war within investor sentiment? NVIDIA earnings will be critical for market direction in the near term, said Orton, who told Reuters last week that the report could be the catalyst to help improve sentiment and see the market break out once again. He also expects the German federal election to play a role in the trend of European equities. On both sides of the Atlantic, Orton said he would be careful about chasing upside. He said he would look for more days like Friday to consider leaning into the rotation that’s taking place. Areas where he sees potential opportunities include:
Financials. Global banks have displayed an earnings resilience for the past few months that Orton said continues to make them attractive. European banks have risen significantly year to date; earnings have been the catalyst coupled with valuations that are still well below those of U.S. banks. Japanese banks also have done well, but they lag their counterparts in the United States and Europe. Orton sees that as a potential opportunity as he expects the Bank of Japan to continue hiking interest rates as wage growth supports the consumer. In the United States, he said don’t forget about the prospect of increased capital markets activity — this industry within financials has been moving sideways for the past few weeks and he believes the recent weakness could present a potential entry for those who missed the trade before the U.S. election.
Healthcare. The negative headlines around a major healthcare company and pharmacy benefit managers, plus uncertainty from the Elon Musk-led Department of Government Efficiency (DOGE), mask constructive price action beneath the surface, Orton said. In fact, healthcare is the second top-contributing sector to S&P 500 gains year to date after financials. Equipment and services companies have been quite strong backed by good earnings, and they fit into the key secular growth trend of an aging population with more chronic diseases. Large-cap biotechnology also has been quite strong, and genomics appears to be breaking out, he said. If interest rates remain well behaved, Orton said strong performance can continue given how weak these two industries have been in years past.
The tech rotation. The hyperscalers have generally been rolling over as investors have been unwilling to come back with too many questions following the news around the Chinese DeepSeek AI model. Orton does not think the AI trade is over, but it is taking a breather. Meanwhile, he said, other areas within technology are shining. He has long favored cybersecurity companies within software, but it has been tough putting new money to work this year given the group’s relative strength. Orton believes the recent pullback presents a possible entry point, and he believes the strength of earnings, coupled with strong guidance and continued corporate investment, make this an attractive part of software to consider. He also sees the equal-weighted Nasdaq as a potential way to position around the broadening of the tech trade.
The global rotation can continue. But be selective. Attractive valuations have existed overseas for a long time, but that’s never led to sustained outperformance. Now earnings growth has started to follow through, but earnings per share (EPS) in Europe haven’t yet exceeded U.S. EPS, and Orton said the big question is whether they can sustain the recent momentum. The story with U.S. small caps has been similar in the past: Attractive valuations and green shoots have not been followed by consistent top- and bottom-line growth. “That said, I think there are reasons to be excited overseas right now,” he said. Aerospace and defense, one of his favorite areas in Europe for the past year, has been performing well on the clear need to increase spending, even with a Russia-Ukraine cease fire. If Germany loosens its brake on debt, higher fiscal spending could benefit more cyclical industries. But the run has been quite strong lately, and Orton cautions against piling into the trade right now.
The week starts with the results of the German federal election, to be followed by key data on consumer prices in Germany, France and Spain before the European Central Bank’s March meeting.
In the United States, the focus will be on NVIDIA earnings and the company’s guidance going forward. On the economic front, we get the second reading of U.S. fourth-quarter gross domestic product (GDP) as well as core Personal Consumption Expenditures (PCE) Price Index data for January. Pay attention as well to the Conference Board’s U.S. Consumer Confidence Survey® on Tuesday, especially in light of last week’s surge in long-term inflation expectations in the University of Michigan Index of Consumer Sentiment for February. The Confidence Survey could provide another piece of evidence if inflation expectations are indeed becoming unanchored. In addition, at least nine U.S. Federal Reserve officials will have a chance to discuss their outlooks for the economy and interest rates.
Note also that the upcoming March 1 weekend is also the end of the 30-day buffer period for new U.S. tariffs on Canada and Mexico. Markets are not reacting to tariff headlines very much anymore, which Orton said is surprising as the Trump administration is now citing tariffs as a revenue tool. He believes the administration’s focus on tariff revenue should add conviction that some sort of tariffs are coming, but clearly markets are not of this view.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Feb. 21, 2025.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
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. The survey’s ratio of bulls to bears is calculated by subtracting bullish responses from bearish responses.
Ballast, in finance, can refer to characteristics, factors or trading strategies that mitigate volatility or provide stability to a security or group of securities.
The Bloomberg Factors to Watch (FTW) function allows a Bloomberg terminal subscriber to monitor the performance of a variety of market factors over a range of time periods and to analyze how individual factors have driven returns historically. Factor data accessible via the FTW function includes value, size, growth, dividend, quality, and profitability factors.
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.
Core PCE, officially known as the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, is a measure of the prices that U.S. consumers pay for goods and services, not including two categories — food and energy — where prices tend to swing up and down more dramatically and more often than other prices. The core PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, measures inflation trends and is watched closely by the U.S. Federal Reserve as it conducts monetary policy.
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.
DeepSeek is a Chinese artificial intelligence startup that in January 2025 became a leading free downloadable app in the United States. This followed DeepSeek’s announcement that its AI model performed as well as market-leading models, and that it was developed at a significantly lower cost. This led to a selloff of well-known U.S. technology stocks on Jan. 27, 2025.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one quarter or one year.
Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
The halo effect in finance reflects a market participant’s inclination to favor a particular company, group of securities, industry, sector, or other area of the market based on previous good experience with the company or group. A halo trade is one influenced by the halo effect.
Hyperscalers refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 31, 2024. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
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.
A multiple, sometimes referred to as the price multiple or earnings multiple, is a measure of a company’s value based on the ratio of its current share price to its earnings per share. This ratio is known as the price-to-earnings ratio, or P/E.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
A pullback is a temporary pause or drop in the price of a security that previously had been rising.
A quintile is a statistical value representing 20% of a given set of data. The first, or lowest, quintile represents the lowest fifth of the data (1% to 20%), and the highest quintile represents the top fifth (81% to 100%).
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
Secular trends are large-scale and ongoing changes in economies and societies that have the potential to drive broad and lasting economic, technological, social or other kinds of changes.
Style boxes are used to group different equity investments by their key characteristics. This can include market capitalization and investment style, showing where specific investments or strategies fit into the overall market.
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.
Unwinding describes the process of closing out what is often a large or complicated trading position.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
Indices
The S&P 500 Index measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The Nasdaq 100® is a stock market index made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index.
The Nasdaq-100 Equal Weighted Index is an equal weighted version of the Nasdaq 100. It includes 100 of the largest non-financial stocks listed on the Nasdaq stock market based on market capitalization and is rebalanced quarterly.
The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. The Russell 1000 Index is a subset of the Russell 3000® Index, which is designed to represent approximately 98% of the investable U.S. equity market. It includes approximately 1,000 ofthe largest securities based on a combination of their market cap and current index membership.
The Russell 1000® Growth Index measures a growth-oriented subset of the Russell 1000 Index, which tracks approximately 1,000 of the large-sized capitalization companies in the United States equities market.
The Russell 1000® Value Index measures a value-oriented subset of the Russell 1000® Index, which tracks approximately 1,000 of the large-sized capitalization companies in the U.S. equities market.
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 Midcap® Growth Index measures the performance of the midcap growth segment of the U.S. equity universe. It includes those Russell Midcap® Index companies with higher price-to-book ratios and higher forecasted growth values.
The Russell Midcap® Value Index measures the performance of the midcap value segment of the US equity universe. It includes those Russell Midcap® Index companies with lower price-to-book ratios and lower forecasted growth values.
The Russell 2000® Index measures the performance of the small-cap segment of the US equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
The Russell 2000® Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 2000® Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2025. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-694543 Exp. 6/24/2025
Stronger than expected earnings have helped the equity market hold up despite recent noise and increased uncertainty.
Last week’s Consumer Price Index came in hot, but the Producer Price Index and retail sales told a different story, giving the U.S. Federal Reserve space to wait and see.
With equities seeing a healthy rotation beneath the surface, areas that Matt Orton, CFA favors considering include secular growth companies, small and mid caps, and select international diversification plays.
Another week, another roller coaster of investor sentiment.
“Between the relentless news flow from Washington, important data releases, and corporate earnings, it’s easy to understand why U.S. equities seem to be stuck in a state of purgatory,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “The recent underperformance of the Magnificent Seven and stalling upward momentum don’t help, either.”
But Orton said it’s worth noting that the market has held up quite well despite the noise and uncertainty. Earnings, which Orton sees as the ultimate arbiter of market direction, continue to be stronger than expected with estimates for the coming quarters and 2025 remaining strong.1 Earnings also have been responsible for a healthy rotation beneath the surface where all style boxes are performing well, but where money has nonetheless been moving out of large-cap growth into large-cap value and mid-cap growth.
“This rotation, coupled with the market’s ability to look past bad news, allows me to be confident that the bull market remains in place,” Orton said.
At the end of the day, he said, profits drive performance, and he favors thinking about diversifying portfolios to areas where profitability looks to be increasing. This means considering areas within financials and information technology as well as looking overseas in search of rising profitability.
“I continue to favor smaller companies, global banks and capital markets companies, global aerospace and defense companies, as well as software within information technology,” Orton said. “Even within fixed income, I think investors can consider selectively adding some duration should rates move higher. However, this is not a market to chase, and I will reiterate the importance of thinking about using downside opportunistically.”
FactSet S&P 500 4Q24 EPS growth consensus expectations
Source: FactSet as of 2/14/25.
Inflation has been front and center between new Consumer Price Index (CPI) data and continued uncertainty with respect to the potential impact of tariffs on inflation. CPI came in hot last week, provoking fears that inflation might be running away even before the impact of tariffs emerges in earnest. But those fears were assuaged over the following days by Producer Price Index data and soft retail sales numbers.
“Putting all of this together, I believe the Fed is in a good place to just wait and see,” Orton said. “The U.S. economy is not crying out for further easing, but there also isn’t much data that would signal that inflation is reaccelerating, necessitating a rate hike.”
This is part of the reason why the yield curve has flattened as rate cut expectations are priced out and economic growth expectations moderate, he said. With this dynamic in place, the market is now reacting less to every word from the U.S. Federal Reserve (Fed) and more to the impact from the totality of fiscal and monetary policy on the direction of corporate earnings.
Earnings season has been quite strong so far, with the S&P 500 Index’s fourth-quarter blended earnings growth increasing to 16.9% versus a pre-season consensus estimate of 11.8%. Financials, specifically banks, are the top contributor to earnings per share (EPS) growth, but sectors like information technology, communication services, consumer discretionary, and healthcare are also reporting solid growth. Earnings for calendar year 2025 are also on track to come in near Orton’s target of 13%.
“It’s worth noting that we’re starting to see EPS expectations diverge a bit between companies with more domestic versus international revenue exposure as a result of anticipated tariffs,” he said. Specifically, for companies that generate more than 50% of sales inside the United States, the estimated earnings growth rate is 9.1%. For companies that generate more than 50% of sales outside the United States, the estimated earnings growth rate is 6.6%.
“This is why I believe selectivity is so important, and why some of my favored parts of the market — global banks, capital markets companies, and software — are all more insulated from the noise,” Orton said. “The other areas l like, such as aerospace and defense, have clear secular growth drivers to support growth going forward.”
Orton remains optimistic on the state of the bull market, but he said that doesn’t mean the path is linear.
“We’re going through some sideways consolidation at the market level right now, but there are some significant changes beneath the surface,” he said.
The DeepSeek news triggered a broad reduction in exposure to the biggest artificial intelligence (AI) winners, and Orton doesn’t think the market has found a bottom in some of the semiconductor companies and ancillary beneficiaries of the capital expenditure (capex) buildout. That, he expects, will probably take through Wednesday of next week when NVIDIA reports earnings. Instead, the market has been rotating toward areas where there is perceived value and where the fundamental outlook continues to improve. This is why European equities have been doing well, Orton said: Earnings are better than expected amid a bleak picture for economic growth, but one that might not be as bad as feared and one where policy changes could help. Additionally, the U.S. dollar is actually down on the year and is one of the worst-performing assets. Orton noted in December that we may have seen a top, but the volatility would be the transmission mechanism into the equity markets.
Orton came into 2025 advocating for considering the potential benefits of diversification — which he said includes thinking about adding some exposure down the market capitalization spectrum, leaning into global banks, adding some international exposure, and better balancing growth and value. That has been playing out, and he continues to expect this to be the story when there is so much uncertainty at the macro level. Rather, he said, consider leaning into the micro and using downside opportunistically rather than chasing the market. Once the dust settles on the AI trade, he thinks there are some attractive opportunities in AI capex beneficiaries that were thrown out with the bathwater. Other themes he thinks are worth considering include:
Secular growth. We’ve seen a split between software and everything else with respect to the AI trade following the DeepSeek news. Orton continues to like the software trade, especially cybersecurity, given the increased number of hacks and continued investment at the corporate level. But secular growth also exists outside of the AI trade, he said, and one secular growth theme relates to healthcare — specifically, the need to find more innovative solutions to drive down costs and improve outcomes for an aging population with more chronic diseases. Healthcare tech has been working well with signs of strength relative to the broad market, he said.
Many of these names haven’t been picked over either, so Orton believes there is still room to run. Defense remains another secular growth theme, especially in Europe, where we’re likely to see more spending. Orton has favored global aerospace and defense, and he expects this will come into even more focus should there be a cease-fire agreement reached in the Russia-Ukraine war. Orton believes the beatdown of U.S. defense companies on the heels of President Trump’s comments about slashing defense spending is likely overdone; it is a subject that Congress would probably address if those comments were serious.
Smaller companies. The Russell Midcap® Index has outperformed the S&P 500 Index year to date, and small caps have been holding up well. The economy remains resilient, and earnings are picking up down market cap. Credit spreads continue to signal strength in the corporate sector and a weaker dollar could help to increase risk appetite, Orton said. Critically, earnings for small caps finally look to be delivering, which is the critical ingredient to sustaining any degree of outperformance. Small caps, as represented by the Russell 2000® Index, are beating expectations for the fourth quarter, and their full-year 2025 estimates remain in the +25% growth range. Nearly 70% of the 634 Russell 2000 companies that have reported results so far are beating expectations, posting +8.5% earnings growth versus +0.4% expectations. Orton said the strength in mid caps should eventually start to move down to small-cap companies, especially as the market continues to look to rotate toward parts of the market where valuations look attractive and growth is still beating expectations.
International diversification. The outperformance of European equities over U.S. stocks has been driven by rotation from the big AI winners, and it has been sustainable so far due to earnings results. About 33% of the STOXX® Europe 600 Index has reported results, and fourth-quarter earnings growth is running at 11% year over year, well above the 5% consensus expectations. The upside surprise to earnings has been driven largely by financials and healthcare, as well as industrials (largely due to one shipping giant). The divergence between winners and losers will probably grow once we get clarity regarding tariffs, Orton said, but global banks appear to be positioned well. Following German elections, the possibility of fiscal expansion could provide additional upside to the market that isn’t fully priced in, Orton said. Outside of Europe, Japan’s gross domestic product (GDP) growth accelerated to 2.8% quarter over quarter annualized in the fourth quarter, which was well above the consensus expectations for 1.1%. Japanese markets remain range-bound, but Orton believes there are selective opportunities for outperformance.
Small caps expected to leave their earnings recession behind
Quarterly year-over-year EPS growth and estimates
Source: FactSet as of 2/14/25.
In addition to headlines from the White House, business surveys this week provide an updated read on market sentiment since the inauguration. These might give a sense for how tariff-related noise might impact the real economy. We also get the January Federal Open Market Committee minutes where Orton would look for any discussion around long-term inflation expectations.
In Europe, Germany’s federal elections are expected to have some important consequences. A two-thirds majority is needed to reform the debt brake — a loosening of Germany’s fiscal straitjacket would be a major policy shift for Europe. In fact, it could significantly alter the European Union’s ability to respond to economic challenges and improve competitiveness. Given the strong rally in the Deutscher Aktien Index (DAX) year to date, Orton said more good news will probably be needed in order to sustain recent gains.
1 Unless otherwise indicated, all data cited is sourced from FactSet as of Feb. 14, 2025.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.
A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.
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.
DeepSeek is a Chinese artificial intelligence startup that in January 2025 became a leading free downloadable app in the United States. This followed DeepSeek’s announcement that its AI model performed as well as market-leading models, and that it was developed at a significantly lower cost. This led to a selloff of well-known U.S. technology stocks on Jan. 27, 2025.
Duration incorporates a bond’s yield, coupon, final maturity, and call features into one number, expressed in years, that indicates how price-sensitive a bond or portfolio is to changes in interest rates. Bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one quarter or one year.
Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 31, 2024. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
The Producer Price Index (PPI), published monthly by the U.S. Bureau of Labor Statistics, measures the average change over time in the selling prices received by domestic producers for their output.
Range-bound is a condition where the value of a security keeps vacillating between the low and high ends of a narrow range. For example, if the 10-year Treasury yield repeatedly vacillated between 3.75% and 4.25%, it would be described as “range-bound.”
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
Secular trends are large-scale and ongoing changes in economies and societies that have the potential to drive broad and lasting economic, technological, social or other kinds of changes.
Style boxes are used to group different equity investments by their key characteristics. This can include market capitalization and investment style, showing where specific investments or strategies fit into the overall market.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
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.
Yield curve flattening describes the convergence of interest rates along the curve.
Indices
The DAX, or Deutscher Aktien Index, is a stock index that represents 40 of the largest and most liquid German companies that trade on the Frankfurt Exchange. DAX member companies represent about 75% of the aggregate market capitalization that trades on the Frankfurt Exchange.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
The Russell Midcap® Index measures the performance of the mid-cap segment of the US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap® Index represents approximately 27% of the total market capitalization of the Russell 1000® companies.
The S&P 500 Index measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The STOXX® Europe 600 Index represents 600 large-, mid- and small-capitalization companies across 17 European countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2025. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-691890 Exp. 6/18/2025
Fourth-quarter earnings have been strong, though uncertainty over tariffs and future policy is impacting management outlooks.
The recent flattening of the U.S. Treasury yield curve reflects a higher bar for further interest rate cuts, fading fiscal deficit concerns, and lower growth expectations due to a “higher for longer” monetary policy outlook.
In this environment, consider opportunities for diversification, says Matt Orton, CFA, whose areas to consider include financials, select international equities, the dollar trade, and small caps.
The market continues to scale a wall of worries, from tariff uncertainty to sticky inflation to earnings.
Still, could a wide range of potential opportunities provide some hand holds along the way?
“I think the selloff was more a pull-forward of valuation concerns around the AI trade, and DeepSeek was the gas poured onto the valuation embers that started to flare up toward the end of last quarter,” Orton said. “Many investors were looking for an excuse to take profits in an environment clouded by uncertainty around tariffs, the strength of the dollar, and the geopolitical implications of this Chinese AI model.”
“I believe that this idea of diversification that I’ve talked about since the end of last year is on full display,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “Market breadth is increasing quite nicely. Areas that have been doing well include financials, healthcare, cyclical pockets of the market, international equities, small caps, and mid caps. So you’re seeing diversification work. There’s money going to work in places in the market where it sees value and it sees the ability of earnings and fundamentals to meet that value.”
Earnings results have been quite strong. Blended S&P 500 Index earnings per share (EPS) growth for the fourth quarter now stands at 16.4% versus a consensus estimate of 11.8%.1 Margins also are currently ahead of last quarter, rising from 12.2% to 12.5%. Earnings breadth has been translating into better price breadth as Orton has expected.
Meanwhile, uncertainty over tariffs and future policy is impacting management outlooks. In fact, the number of S&P 500 companies citing “tariffs” on earnings calls is at its highest point since the second quarter of 2019. If this pace continues through the remainder of the earnings season, the fourth quarter will record the highest number of S&P 500 companies citing “tariff” or “tariffs” on earnings calls for a quarter over the past 10 years.
Elevated currency volatility and the strong dollar also have been headwinds that the market thus far has been able to overcome. That’s largely due to earnings resilience and increasing breadth, which are both rooted in the strength of the U.S. economy, Orton said. However, it’s worth following the recent flattening of the U.S. Treasury yield curve, which has been driven largely by a widening breakeven in the front end and declining real yields for bonds with longer tenors. The front end reflects a higher bar for further interest rate cuts while the long end reflects fading fiscal deficit concerns as well as lower growth expectations due to a “higher for longer” U.S. Federal Reserve (Fed).
“While the market has been able to push higher despite all of these crosscurrents, I believe that investors should tread cautiously in the near term,” Orton said. “I don’t like the Magnificent Seven’s recent price action, and there are some near-term catalysts with asymmetric risk profiles, including the Consumer Price Index on Wednesday and more updates on tariffs. We need to see a better reset in investor positioning as well as a top in the dollar and a broad resumption in risk appetite — look to bitcoin as a signal — before I will be confident that we’re exiting the broad range we’ve been in since December.”
Diversification across sectors, market capitalizations, and geographies has worked well, and Orton believes there are still plenty of opportunities in the market. Consequently, he has a few key themes that he believes are important to consider right now.
Eight S&P 500 sectors are growing EPS faster than the pre-season estimate
FactSet S&P 500 fourth-quarter EPS growth consensus expectations
Source: FactSet, as of 2/7/25. The numbers in parentheses indicate the number of companies that have reported fourth-quarter earnings so far, followed by the total number of companies in each category.
The numbers in parentheses indicate the number of companies that have reported fourth-quarter earnings so far, followed by the total number of companies in each category.
Everyone knows that tariffs are a negotiating tool for President Trump, but they still create significant near-term uncertainty, Orton said. If we see tariffs implemented to the scale that Trump has broadcast, that could represent a big supply shock to America’s key trading partners and closest allies. Tariff policy also could challenge corporate America if it ends up delivering a self-inflicted supply shock that upends supply chains. Yet through all the noise, Orton believes it’s important to avoid overreacting to headlines as the end result will probably not be the worst-case scenario (last week’s tariffs announcement on Canada and Mexico is a perfect case in point). Trump wants favorable terms for U.S. companies and the U.S. economy as well as a more coordinated North American energy policy. Trump also doesn’t want to damage the U.S. economy or to risk a recession during his second term, which meaningfully reduces the worst case of tariffs from playing out, at least for more than a week or two, Orton said. Also, he said the need to use tariffs to “fund” new fiscal spending might be lower than anticipated given some potential budget witchcraft.
“For now,” he said, “I would tread carefully and use any 5%-plus tariff-induced selloffs opportunistically.”
The DeepSeek rout triggered large rotations from technology and artificial intelligence-exposed industrials and utilities as managers re-calibrated their exposures. Orton is cautious in the near term, particularly due to the sizeable sentiment divergence between cautious hedge funds, optimistic real money, and greedy retail investors. This, he said, tends to translate into downside asymmetry. But he remains optimistic and believes the “AI 2.0” trade will rebound as more of its industrial and data center companies release earnings. He said one thing is crystal-clear following the earnings releases for the hyperscalers: nobody is slowing down their capital expenditures (capex). In fact, we’ll see a projected $290 billion spent by just four hyperscalers in 2025, which is well above expectations. This is not baked into many share prices, Orton said, adding that he would consider exploring the high-quality companies that took a 10% to 30% haircut due to DeepSeek. Selectivity is critical, he said.
“That train of AI capex is not slowing down,” Orton said. “I believe it’s just going to continue to accelerate.”
On the flip side, he said it’s worth calling out a few of the winners from the AI rotation. Financials have been a large beneficiary coming off strong earnings and increased flows, particularly European financials. The positioning imbalance between the United States and Europe is supportive, with the Euro STOXX 50® Index Futures’ open interest at decade lows and commodity trading advisors (CTAs) buying equities, putting a floor on price action. Orton continues to like developed-market banks and particularly high capital-return European Union banks right now. Flows have picked up and performance has been strong, but Orton believes there is room for considering adding to gross exposure within portfolios with earnings coming in strong.
The long U.S. dollar trade is one of the most crowded and a function of 1) tariff concerns and 2) defensive risk-off hedges. It looks a bit overdone right now relative to rates, and Orton said there is an asymmetry for the dollar to weaken now. However, there is always room for a crowded trade to get more crowded, especially given tariff uncertainty. Even U.S. Treasury Secretary Scott Bessent essentially acknowledged that we’ll be living with a strong dollar in his comments last week. This is a risk to equities, especially for companies that derive more revenues from overseas. It’s also a headwind to investors overseas who don’t or can’t hedge currency risk. But the Wall Street consensus is for tariffs and a strong dollar, and there is the chance that we could see President Trump be more likely to pursue politics supportive of a weaker dollar to make U.S. manufacturing more competitive. This would be bullish for domestic multinationals and is not baked into current market expectations, Orton said.
Other beneficiaries of volatility in the dollar include more domestically exposed small- and mid-cap companies. Earnings have been showing necessary signs of life, with small caps in the Russell 2000® Index handily beating expectations with 8.6% earnings growth versus a pre-earnings consensus estimate of 2.3%. Importantly, the 2025 outlook remains strong with forecasts of 5.9% top-line growth and 25.8% bottom-line growth for the Russell 2000. We’re seeing similar positive results for mid-cap companies, and the market has been rewarding this segment given fewer concerns around higher rate implications. The Russell Midcap® Index is up 4.28% versus 2.55% for the S&P 500 year to date, and it has held up much better during periods of volatility. Orton continues to favor considering adding exposure to small- and mid-cap equities to help diversify portfolios.
It’s all about inflation this week with the U.S. Consumer Price Index report on Wednesday. Fed Chair Jerome Powell’s semiannual testimony before Congress on Tuesday and Wednesday also will be closely watched for any shifts in tone, particularly after the latest payroll report sent U.S. Treasury yields higher.
Beyond the United States, U.K. gross domestic product will show how much economic momentum the British economy retained into 2025. Also, Bank of England Monetary Policy Committee member Catherine Mann speaks for the first time after surprisingly voting for a 50-basis point rate cut last week.
1 Unless otherwise indicated, all data cited is sourced from FactSet as of Feb. 7, 2025.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Asymmetric risk describes a risk posed when the gain (or loss) that could result from the movement of an underlying asset or metric in one direction is significantly different from the loss (or gain) that would take place from a move in the other direction.
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%.
Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.
Bottom-line growth describes growth in a company’s net income — that is, its income after paying expenses, taxes and other costs — over a specified period of time.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Breakeven yields, or inflation rates, reflect what market participants expect inflation to be over a specified period of time, on average. For example, the 10-year breakeven inflation rate reflects what market participants expect inflation to be in the next 10 years, on average. It is calculated using 10-Year U.S. Treasury Constant Maturity Securities and 10-Year Treasury Inflation-Indexed Constant Maturity Securities. Breakeven yields widen when the difference between the inflation-linked inflation yield and the face-value yield on the bond grows bigger.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
A commodity trading advisor (CTA) is an investment professional or firm that provides client-specific advice on buying and selling futures contracts.
A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.
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.
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.
DeepSeek is a Chinese artificial intelligence startup that in January 2025 became a leading free downloadable app in the United States. This followed DeepSeek’s announcement that its AI model performed as well as market-leading models, and that it was developed at a significantly lower cost. This led to a selloff of well-known U.S. technology stocks on Jan. 27, 2025.
Defensive securities provide consistent returns and growth regardless of whether the overall market is rising or falling. Companies with securities 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.
Fiscal deficit spending consists of government spending over a specific period of time that exceeds the revenues that the government takes in for the same period.
Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset, sector, or index. It typically is measured on a quarterly or monthly basis. Investors and others look at the direction of fund flows for indications about the health of specific securities and sectors or the overall market.
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.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one quarter or one year.
Gross exposure refers to the total amount of a portfolio’s investments and accounts for the value of both a portfolios short and long positions. It reflects the portfolio’s total exposure to financial markets. The higher the gross exposure, the larger the potential risk.
A haircut in finance refers to a value ascribed to an asset that is considered to be below its market value.
Headwind is a term used to describe events or market forces that hinder the prospects for performance in an individual investment or group of investments.
A hedge is an investment or investment strategy that is designed to lessen the potential for losses in other investments. The price of an investment considered to be a hedge often moves in the opposite direction of the prices of the investments being hedged.
Hyperscalers refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
A long position refers to the purchase of a security with the expectation that it will rise in value, reflecting a bullish attitude.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 31, 2024. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Open interest is the total number of outstanding derivative contracts, such as futures, that have not been settled. Open interest increases as new money enters the market and decreases as money flows out of the market.
The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
Real yield curve rates, commonly referred to as “Real Constant Maturity Treasury” rates, on Treasury Inflation-Protected Securities (TIPS) at “constant maturity” are estimated by the U.S. Treasury from the Treasury’s daily par real yield curve. These par real yields are calculated from indicative secondary market quotations obtained by the Federal Reserve Bank of New York. The par real yield values are read from the par real yield curve at fixed maturities, currently 5, 7, 10, 20, and 30 years. This method provides a par real yield for a 10-year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity.
A risk-off hedge is one that is considered to be a safe haven in bearish market environments.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing or more variable data.
Tenor refers to the time remaining in a bond before it reaches its maturity date.
Top-line growth describes the total growth in a company’s income over a specified period of time.
A “wall of worry” is an expression in finance used to describe stocks that manage to rise even when external factors raise questions about a capital market’s ability to rise.
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.
Yield curve flattening describes the convergence of interest rates along the curve.
Indices
The S&P 500 Index measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The EURO STOXX 50® Index is a blue-chip index designed to represent 50 of the largest companies from eight Eurozone countries: Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands, and Spain.
The EURO STOXX 50® Index Futures tracks futures and options trading within the EURO STOXX 50® Index.
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 US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap® Index represents approximately 27% of the total market capitalization of the Russell 1000® companies.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2025. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-687006 Exp. 6/10/2025
Last’s week’s deep selloff following news around the DeepSeek artificial intelligence (AI) model efficiency and this week’s turbulence over tariffs have ignored the strength of underlying U.S. fundamental economic trends.
Matt Orton, CFA, believes the AI trade will endure, but with an added focus on the strength and durability of earnings for AI companies.
More negative news could lead to more volatility and pullbacks – but also to new opportunities, Orton said.
If anyone needed more evidence that this is now a higher-volatility bull market, the last two Mondays provided it.
Last week, an over-reaction to news around the Chinese-developed DeepSeek AI model led to a meltdown across much of the AI trade, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. Semiconductors, data center and adjacent companies, power and energy companies — really everything AI-related except software — saw some of their most significant single-day losses since the COVID-19 pandemic or the Global Financial Crisis.1 Leading AI chip designer NVIDIA set a new record for the most market capitalization lost in a single trading day by a single company, more than doubling the previous record that it also set in September of last year.
“I think the selloff was more a pull-forward of valuation concerns around the AI trade, and DeepSeek was the gas poured onto the valuation embers that started to flare up toward the end of last quarter,” Orton said. “Many investors were looking for an excuse to take profits in an environment clouded by uncertainty around tariffs, the strength of the dollar, and the geopolitical implications of this Chinese AI model.”
This week, the dollar surged, oil prices rose, and markets fell on Monday following President Trump’s weekend announcement of new tariffs on Canada, Mexico, and China.
These reactions, however, ignore the strength of underlying fundamental trends, Orton said. Fourth-quarter earnings have been strong, and we received further reinforcement last week, particularly around the hundreds of billions of dollars that are still planned to be spent on AI infrastructure going forward.
“There are a number of high-growth, high-quality companies that were thrown out with the bathwater that I believe are worth considering at these valuations,” he said.
At the same time, Orton noted that the broadening of earnings growth continues to translate into increased breadth across prices. The average stock in the S&P 500 outperformed the broader index in January because it was undervalued and is delivering growth.
“I’m watching for any pullbacks in high-quality companies that lean into secular growth drivers due to tariffs or any other macroeconomic risk,” he said. “For investors who have been waiting on the sidelines for a good opportunity to redeploy capital, I believe any further weakness is a good time to consider doing so.”
Orton said it’s hard to understand why we saw such extreme moves across the AI complex on Jan. 27, the Monday following the news that downloads of DeepSeek had risen dramatically, particularly in light of the strong earnings and guidance that we just heard from the largest chip manufacturer a week earlier (when we already knew about DeepSeek’s newest model).
“I view DeepSeek’s model as a positive overall as it simply accelerates the access and viability of AI at the user-level,” he said. “I spent a lot of time last week talking with experts, listening to the CEOs of AI-adjacent companies, using AI to parse through earnings transcripts with a focus on capital expenditures and R&D, and I went into the weekend feeling more confident about the long- term thesis.
“That doesn’t mean every AI-related company deserves the valuations they’ve been afforded,” he said. “I believe some will not recover from the selloff, and deservedly so.”
But he believes just as many will come back, and he is watching areas such as application-specific integrated circuits (ASICs), electronic design automation (EDA), and the data center supply chain.
“I expect that this will be an increasingly idiosyncratic market,” Orton said, “and I believe positive earnings will be the key to recovery.”
Adding more variables to the current market environment are:
The new tariffs announced over the weekend on Canada, Mexico, and China. This is just the first strike, Orton said, with imports from the European Union expected to be hit within the next month or two, and a universal tariff expected to come in April. Based on the campaign, he believes these would be temporary with explicit goals in mind. But that makes it even more difficult to model or project their inflationary impact. He expects this uncertainty to contribute further to volatility, especially with respect to the dollar. The strength of the dollar has been problematic, and especially so to the emerging market complex.
The more hawkish reaction function of the U.S. Federal Reserve (Fed). This means that the “Fed put” — the expectation that the Fed would step in and implement policies to help support a declining equity market — could wait for a larger decline in equities, and that we should expect higher volatility given the uncertainty around the future path of inflation, Orton said.
“I don’t think this derails the bull market, but it certainly could lead to sharper pullbacks on negative news,” Orton said. “I would consider using pullbacks opportunistically, especially if we see anything in the range of 5% to 10% or more. All of these developments also embolden my support for giving close thought to better diversifying portfolios across asset classes, sectors and industries, market capitalizations, and geographies.”
The market understandably reacted to tariffs at the start of this week. President Trump’s hard-hitting new tariff plan caused the dollar to spike and dampened already weak sentiment. We’re likely to see legal battles slow things down a bit, but Orton said there could be very tangible risks to a market that has so far been able to shake off bad news. It will take some time to fully understand the impact of these tariffs on supply chains and the ultimate economic and earnings impact, he said. This largely is because we don’t know how long these tariffs will remain in place or what the tangible goalposts for our allies would be. A 25% tax on two of America’s key economic allies, Canada and Mexico, plus an extra 10% hit on China, is a huge shift and more significant than the market anticipated.
All of this turbulence pulls attention away from the positive underlying fundamentals of the market, Orton said. The blended fourth-quarter earnings growth rate stands at 13.2% versus a consensus estimate of 11.8%, with strength coming broadly across sectors. Financials have been particularly strong with positive outlooks from management teams. Orton said he continues to favor banks and capital market companies in part because they help to add context to the noise around tariffs. They also play into the strength of the U.S. economy and could stand to benefit from the promises for deregulation made by the Trump administration. The net profit margin for the S&P 500 Index also stands at 12.1%, which is about in line with last quarter and well above last year’s 11.3% and the index’s 5-year average of 11.6%. There are concerns around the potential impact of tariffs on corporate margins, which Orton said further increases the importance of paying attention to idiosyncratic risk.
“This is a market where dispersion remains elevated and knowing what you own is absolutely critical,” he said. Despite elevated uncertainty, he believes there are still some interesting areas across the market, including:
No, the AI trade isn’t over. What is over is the blind share appreciation of anything that happens to be AI-adjacent, Orton said. Also, he believes the market will be much more focused not only on the earnings strength for many of these companies, but on the durability of those earnings. And the good news is that there are so many companies that saw declines of 10% to 30% or more declines where earnings per share (EPS) continue to accelerate and where pipelines have strong visibility out at least one or more years. There are going to be bumps, especially with the additional negative catalyst of tariffs, but Orton said he would use additional downside to look for potential opportunities.
Small caps posted a strong January, with the Russell 2000® Index up 2.6%, in line with the S&P 500. Mid caps did even better with the Russell Midcap® Index up 4.19%. Valuation differences with large caps remain near historic levels, and earnings growth is finally starting to show signs of life. While it’s early for smaller company results, Orton said earnings surprises are running better than both last quarter and at this point last year with 2025 estimates actually rising. The imposition of tariffs likely keeps the Fed on pause and further pushes out a resumption of rate cuts, but he does not believe that would be a problem for small caps. Interest costs are only about 2.3% of sales and are expected to remain stable as financing costs are more closely linked to shorter-term rates. Sales are expected to continue to increase, and with the backdrop of relatively stable financing costs, there is a positive effect on margins and earnings per share. “The market is totally missing this, and a constructive earnings season could provide a catalyst to finally see some sustainable outperformance of small caps over the broader market,” Orton said.
International markets: Earnings revisions are broadly positive across Europe, and profit momentum is improving. European banks have been posting strong growth, which fits with one of Orton’s 2025 themes: to consider leaning into global developed-market banks. Tariffs are now tangible, and coupled with the strength of the dollar, present a strong headwind to continuing international outperformance in the near-term. But Orton said the strength we saw in January should be a signal to investors that things might not be as bad as feared overseas. Clearing a very low bar could present opportunities for upside, he said. It also fits within the context of his support for thinking about building diversified portfolios that could help to insulate against big swings like we saw last week in the AI trade. An active approach can focus on the companies least likely to be caught up in potential trade wars, he said.
Percent of S&P 500 sector by market cap reporting earnings per week
Source: Bloomberg, as of 1/31/25.
It will be a busy week both on the macroeconomic data and earnings fronts. The Institute for Supply Management (ISM) manufacturing Purchasing Managers’ Index will come out on Monday, followed by an updated Job Openings and Labor Turnover Survey (JOLTS) report on Tuesday and ISM services data on Wednesday. The Bank of England makes a rate decision on Thursday and the U.S. payroll report arrives on Friday.
Two critically important mega-cap companies that have held up relatively well through all of the volatility so far will report earnings. Earnings reports also accelerate for consumer staples, healthcare, and industrials. Investors will closely follow not only the actual results and guidance, but management commentary around catalysts that are front of mind like the strength of the dollar and how tariffs could impact their businesses.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Jan. 31, 2025.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
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Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.
Blind share appreciation describes the unrealistic expectation of investors who may purchase stocks in a particular industry, sector, or other area of the market and expect their values to rise regardless of material differences in company management, market position, or performance.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.
DeepSeek is a Chinese artificial intelligence startup that in January 2025 became a leading free downloadable app in the United States. This followed DeepSeek’s announcement that its AI model performed as well as market-leading models, and that it was developed at a significantly lower cost. This led to a selloff of well-known U.S. technology stocks on Jan. 27, 2025.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
An earnings surprise is when a company’s reported earnings either exceed or come in below the expectations of analysts who cover the stock.
The term “Fed put” is an adaption of the option term “put,” and it describes the belief among market participants that the U.S. Federal Reserve would step in and implement policies to limit the equity market’s decline beyond a certain point.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
Hawkish, dovish, and centrist are terms used to describe the monetary policy preferences 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.
Headwind is a term used to describe events or market forces that hinder the prospects for performance in an individual investment or group of investments.
The Institute for Supply Management produces several surveys assessing business conditions and outlooks across a variety of industries. They include the ISM Purchasing Managers’ Index (PMI), which measures the prevailing direction of economic trends in the manufacturing sector, and the Services ISM® Report on Business®, which is based on data compiled from purchasing and supply executives and reflects 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 Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics. The survey’s job openings rates consider month-to-month changes in the number of job openings reported on both a state and national level.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.
The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
A pullback is a temporary pause or drop in the price of a security that previously had been rising.
A reaction function refers to a model that describes how a central bank adjusts monetary policy in response to macroeconomic trends or changes.
Secular trends are large-scale and ongoing changes in economies and societies that have the potential to drive broad and lasting economic, technological, social or other kinds of changes.
Visibility reflects the degree to which a company’s management or the analysts who follow it can reliably estimate future near- or long-term performance.
Indices
The S&P 500 Index measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The 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 US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap® Index represents approximately 27% of the total market capitalization of the Russell 1000® companies.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-684044 Exp. 6/3/2025
