Feb. 27, 2023: Not time to buy the dip

A continuation of stronger than expected economic and inflation data last week continued to pressure equities and send interest rates higher. The core Personal Consumption Expenditures Price Index jumped 0.6% in January and 4.7% from a year ago, while consumer spending surged 1.8% last month, the biggest increase in nearly two years.

“I would be careful about extrapolating this to mean the U.S. economy is reaccelerating, but it certainly provides more evidence that a soft-ish landing remains possible,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “I believe growth is going to continue to slow, rates are going to remain higher, and thus the environment’s going to be a bit more challenging. But the case for a soft landing continues to hold up, and that supports the case for continuing to own equities, which I believe will look more attractive as we get through the reset that we’re going through.”

Strong economic and inflation data also gives the U.S. Federal Reserve (Fed) more cover to keep rates higher for longer. Given the level of strength in the recent data, Orton said there is now an asymmetric upside risk to the Fed terminal rate, which is why we saw such pressure on risky assets on Friday with front-end yields jumping higher. The 2-year U.S. Treasury yield recorded its highest close in almost 16 years as investors are now almost completely pricing in a third 25-basis point (bp) rate hike.

“Equities, however, still seem disconnected from the big moves in fixed income and there is still more normalization to come, particularly in the higher-duration, lower-quality parts of the market,” Orton said. “This is why I remain defensive and continue to prefer leaning into quality, in particular within growth at a reasonable price (GARP) and dividend-growing companies that have held up nicely through the recent market volatility.”

Despite the losses this past week, the Nasdaq Composite Index is down just under 1% in February despite 2-year yields that have surged more than 70 bps and 10-year yields that are up more than 50 bps. The index is still up nearly 10% year to date while the Dow Jones Industrial Average is down over the same period. Orton said this fits with performance across the broader market, where consumer discretionary and information technology are the two best-performing sectors in the S&P 500 Index both month to date and year to date. That, he said, highlights the disconnect that still exists between the reality of a higher-for-longer rate environment and the positioning-fueled rally that is starting to roll over. Earnings momentum also continues to weaken for many companies in these sectors, further pointing to the likelihood of additional downside as the reality of economic fundamentals sets in. He said it has been encouraging to see factors like value, profitability, and earnings revisions finally outperforming while volatility, short interest, and leverage were on the opposite side. There is still quite a bit of work to be done across the equity market to catch up to the move in rates and Fed guidance, but Orton said that doesn’t mean there aren’t reasons for optimism going forward or that there couldn’t be sector-specific opportunities.

“It’s also worth noting that information technology and consumer discretionary are not monoliths,” he said. “These are incredibly diversified sectors and stock-picking will be important to navigating the choppiness going forward.”

Two of the best-performing S&P 500 sectors in 2022 have lagged meaningfully this year, despite strong earnings results and guidance. Healthcare and energy are down -5.7% and -4.0% year to date, respectively, meaningfully underperforming the 3.4% gain for the S&P 500. The healthcare sector is reporting the second-largest earnings per share (EPS) surprise for fourth-quarter earnings and it’s one of the few sectors to report EPS results ahead of expectations. Orton said he would expect healthcare to benefit if speculative positioning unwound away from the higher-duration parts of the market. The other big underperforming sector year to date is energy, despite reporting the highest EPS growth of 57.7% and being the largest positive contributor to year-over-year earnings for the S&P 500. If energy were excluded from the index, the blended earnings decline for the S&P 500 would grow from -4.8% to -8.9%. It’s also worth noting that crude oil is not a long-duration tech stock caught in the updraft of the recent liquidity-fueled mania. It’s a fundamentally driven asset that’s seen substantial supply management from the Organization of the Petroleum Exporting Countries (OPEC) and its partners. And the prevailing economic narrative has shifted from one where Fed hikes are likely going to lead to a tanking of the U.S. economy, and falling demand, to one where the Fed will have to hike and keep rates high to curb excess demand. This latter scenario is much more bullish for oil, and Orton said he would expect that to support earnings growth as well as continued free cash flow generation and the return of capital to investors. Given the meaningful underperformance of energy year to date, it certainly looks appealing right now, he said.

Globally, one sector worth highlighting as we pass the first anniversary of Russia’s invasion of Ukraine is aerospace and defense. The tone at the Munich security conference, the escalation of western support to Ukraine, and the increased risks of Chinese support to Russia will keep us on our toes and highlight the need for higher defense spending, particularly in Europe, Orton said. Defense spending as a share of gross domestic product (GDP) has been falling steadily over recent years. In the early 1960s it was 6.3% of global GDP. By 2021 it was 2.2%. The global aerospace and defense sector has rallied relative to global equities but is still 14% below its 2019 relative highs and 8% below where it was five years ago.

One key reason not to chase the market higher is that the Fed will likely keep up hawkish rhetoric heading into the March Federal Open Market Committee meeting, particularly if the data this week remains strong, which is what Orton said he expects. There’s no way around the fact that the inflation data last week was “pretty brutal,” he said, with headline and core inflation rising well more than expected. Revisions can explain most of the miss on a year-over-year basis, but a 0.6% monthly rise in core (versus an expected rise of 0.45%) is still a nasty miss in the wrong direction. Moreover, with spending growth higher than expected (1.8% versus a forecast 1.4%), the Fed’s concern about supply/demand imbalances remains highly relevant, and the re-pricing of Fed expectations this month looks justified. It’s also worth paying attention to the labor market components in the Conference Board’s U.S. Consumer Confidence Survey^® this week. The gap between “jobs plentiful” versus “jobs hard to get” has started to widen, and a further move in the wrong direction would point to some serious supply issues that remain due to labor shortages, which are particularly acute across small businesses.

“It would be good news for keeping consumption going, but bad news for inflation,” Orton said. “It also would point tangentially to additional pressure I expect in certain parts of the equity markets.”

What to watch

The hot string of January data culminated with a robust income, spending, and PCE price report on Feb. 24. This week will provide a sneak peek into whether the momentum lasts into February. Labor market components in the Conference Board’s Consumer Confidence Survey should be in focus this week. The “jobs plentiful” index increased for a third straight month in January, presaging the strong January non-farms payroll report. Along with the benchmark revisions to that jobs report, and the surprise increase in Job Openings and Labor Turnover Survey (JOLTS) job openings in December, indicators point to a more resilient labor market than appeared to be the case in late 2022. There will also be plenty of inflation numbers out of Europe including GDP reports.

This week's data releases

Monday	U.S. durable goods; Eurozone Economic Sentiment Indicator and Consumer Confidence Indicator; Bank of Japan bond purchases
Tuesday	U.S. wholesale inventories, Conference Board Consumer Confidence Survey; Consumer price indexes (CPI) from France and Spain; GDP from Canada, France, India, and Turkey; Japan industrial output; Australia retail sales
Wednesday	Germany CPI; S&P Global Purchasing Managers’ Index™ (PMI) manufacturing reports for China, Eurozone, France, and Germany; U.K. house prices; Australia GDP
Thursday	U.S. initial jobless claims; Eurozone CPI and unemployment; Brazil and Hungary GDP
Friday	Eurozone Services PMI and industrial producer price index; Caixin China General Services Purchasing Managers Index; Turkey CPI; Italy GDP

 

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.

Core inflation is measured by the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, also known as the core PCE 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.

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the U.S. Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.

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%.

Equity duration is the cash-flow weighted average time at which investors can expect to receive the cash flows from their investment in a company’s stock. Longduration stocks include fast-growing technology companies, including those that may not pay any dividends in their early years, while short-duration stocks tend to be more mature companies with higher ratios to dividend to price.

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

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

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.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

Profit factor investing considers the gross profit of an investment divided by the gross loss (including commissions) for the entire trading period. This method is used to assess the amount of profit per unit of risk, with values greater than one indicating a profitable system.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

Short interest is the number of shares that have been sold short and remain outstanding. Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price. Short interest often is seen as an indicator of current market sentiment. Rising short interest signals that investors have become more bearish. Falling short interest signals that they have become more bullish.

Leverage investing refers to the use of debt to enhance returns from an investment.

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 Organization of the Petroleum Exporting Countries, also known as OPEC, was founded in 1960 and is a permanent organization of 13 oil-exporting developing nations that coordinates the petroleum policies of its member countries, which are Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Libya, the United Arab Emirates, Algeria, Nigeria, Gabon, Angola, Equatorial Guinea, and Congo.

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.

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

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

The Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics.

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

The Eurozone Economic Sentiment Indicator (ESI) is a composite indicator combining judgments and attitudes of consumers as well as businesses in industry, construction, retail trade, and services by means of a weighted aggregation of standardized input data series.

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

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

S&P Global Purchasing Managers’ Index^™ (PMI) surveys provide monthly indicators that track economic trends in more than 40 countries and regions, including the Eurozone.

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

The Eurozone Services PMI (Purchasing Managers’ Index) is produced by IHS Markit and is based on original survey data collected from a representative panel of around 2,000 private sector service firms. National data are included for Germany, France, Italy, Spain, and the Republic of Ireland. These countries together account for an estimated 78% of Eurozone private sector services output.

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

The Caixin China General Services PMI, compiled by IHS Markit, tracks sales, employment, inventories, and prices in China’s services industry. It is based on data compiled from monthly replies to questionnaires sent to purchasing executives in more than 400 companies. Survey responses reflect the change, if any, in the current month compared to the previous month based on data collected mid-month. A reading above 50 indicates expansion, while anything below that points to contraction.

The Turkey Consumer Price Index, published by the Turkish Statistical Institute, measures the changes of the current retail prices of goods and services purchased by consumers over a given time period.

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

The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq.

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

 

RJIM23-0115 Exp. 6/27/2023

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Feb. 21, 2023: Something's gotta give

The market is finally coming around to listening to what the U.S. Federal Reserve (Fed) has been saying for quite a while – that rates will stay higher for longer – and that growing recognition could make for a bumpy ride in the near future.

“I believe there’s more normalization that still has to happen in equities before we can sustainably move higher,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “We’ve got to reprice out some of the excess that has built up in the higher-duration areas of the market and see some rotation back into the higher-quality parts of the market where there is stability of earnings and where you are seeing fair valuations and free cash flow.”

Treasury investors have quickly adjusted to a continuation of better than expected economic data, and the rate cuts that were priced in have basically disappeared. Expectations for the federal funds rate continue to see upward pressure, with peak fed funds pricing in about an 80% chance that the Fed hikes by an additional 25 basis points (bps) in June, taking the terminal rate to 5.25% to 5.5%. The rate cuts priced for the second half of 2023 have stabilized in a 20- to 25-bp range, less than half of that expected pre-payrolls, which exceeded 50 bps. Risky assets, however, remain surprisingly resilient with the S&P 500 Index down only 1% to 2% despite terminal rate expectations being revised about 40 bps higher. In particular, there remains a meaningful disconnect in higher-duration, lower-quality equities that have led the rebound in 2023 and now refuse to adjust to reality. The Nasdaq Composite Index has returned 13.12% year to date, well ahead of the 6.48% gain for the S&P 500, which has been outperforming the Dow Jones Industrial Average’s gain of 2.35%. Over the past two weeks, 10-year U.S. Treasury yields have jumped nearly 30 bps yet the Nasdaq is down only -1.62%, barely underperforming the broader S&P 500’s loss of -1.27%. Even adjusting for the significant gains in the largest tech weights, the Nasdaq 100 Equal Weighted Index actually does better, declining less than 1% over the past two weeks as yields shot higher! Also problematic is that the resiliency of rate-sensitive, growth-oriented companies is taking place at the same time as these companies experience the strongest degree of weakening earnings momentum since 2010. The confluence of rising yields, an unwind of recent positioning/flow/short squeeze-driven technical exuberance, and a negative combination of relatively high valuations and deteriorating earnings momentum do not paint a healthy picture for these growthiest companies.

“Something’s gotta give as the market continues to converge around the guidance from the Fed,” Orton said. “This is why I continue to favor remaining more defensive in positioning.”

Part of the resiliency in equities can be attributed to increased hopes of a soft landing: If rates have to stay higher for longer, then at least that means a stronger economy too, right? While Orton said he believes that a better than anticipated economic outcome would provide some insulation to 2023 earnings, it wouldn’t be experienced evenly across all sectors or industries. And if this is the case, then he said we still need to see further movement at the longer end of the Treasury curve, which remains deeply inverted. Last week’s Producer Price Index (PPI) and jobless claims data has, again, drawn a stronger than expected outlook for inflation and labor market conditions. PPI printed well above expectations while jobless claims below 200,000 continued to highlight labor market tightness. If the economy is as resilient as the data might suggest, then the long end is still implicitly pricing too many cuts (i.e., a hard landing). That needs to normalize before the market can move higher sustainably. This scenario would put pressure on higher-duration and low-quality equities that remain disconnected from reality. Last week, volatility and short interest were the two best-performing factors while value and profitability were among the worst. Retail earnings this week will also be very important to follow, providing some important insight into the state of consumer demand, the trajectory of economic growth, and profitability more broadly.

“I continue to believe in leaning into quality, particularly as the market continues to adjust to the reality of higher for longer,” Orton said. Two-year yields are near 15-year highs, the 10-year yield has room to move higher, financial conditions are tightening again, and the dollar seems to be finding some footing. All of this points to at least a partial unwind of the rally we’ve seen this year. Quality has held up reasonably well all things considered but going forward Orton said he expects investors to reward stable earnings growth and profitability, and to start caring again about not overpaying for growth. Within this context, he said he believes growth at a reasonable price (GARP) could remain strong. That’s because decreasing probabilities of a hard landing have supported growth more broadly, but it’s the more reasonably valued growth companies that are likely to lead in a higher-for-longer rate environment. Dispersion is also very high, with more than a 20% gap between the best- and worst-performing sectors (consumer discretionary +16.3% versus energy -4.19% year to date). Communication services and information technology are also up double digits over this period, and a normalization over the coming weeks could see a rotation to some of the sectors, such as energy and healthcare, that have lagged meaningfully year to date but where fundamentals remain strong.

Small caps still look attractive, Orton said, and underperformance over the last two weeks helps to provide a better entry point. Small-cap fundamentals have the opportunity to outperform large on an earnings and margin basis for the first time in a while, providing a performance catalyst to an already comparatively cheap asset class. Analysts have taken an axe to small-cap earnings estimates for 2023 — marking them down by -22% over the past year, while large-cap earnings forecasts are down just 11% from their May 2022 highs. Small-cap earnings are also coming in better than expected, which is not the case for the S&P 500. Russell 2000^® Index earnings are down -2.7% versus expectations of -13% for the 28% of companies that have reported so far. It’s also worth noting that valuations, particularly for higher-quality small-caps (i.e., S&P SmallCap 600^® Index), remain near historical lows and are baking in a hard landing not seen since the 2008 recession. Flows into small remain anemic and could provide strong tailwinds should they pick up. From a technical perspective, small caps never made a new low in October, unlike the S&P 500 and Nasdaq Composite.

Globally, Orton said he continues to prefer emerging markets. European markets, as measured by the STOXX Europe 600 Index, are at 10-month highs and have retraced about 80% of the bear market trend — an impressive feat considering that a recession was a forgone conclusion by most all last year. Orton said he believes the recent U.S. Consumer Price Index (CPI) report should be a reminder that the European Central Bank still has more work to do and that markets may be too sanguine. The move in European banks is justified with real yields finally positive, but he said he worries that most other cyclical sectors have moved too far, too fast. However, there is still room to run in emerging markets. Valuations remain attractive and outperformance relative to global markets has lagged that of Europe or developed international equities more broadly. Asia ex-China remains Orton’s preferred region within emerging markets. It is the most direct play on China re-opening, it trades at a larger discount than usual to global equities, and there are signs of earnings momentum turning. Indonesia, the Philippines, South Korea, and Taiwan all have outperformed over the past few weeks even as China took a breather.

What to watch

Retail earnings will be the highlight this week. Guidance will be important for understanding the state of the American consumer, particularly after a strong January retail sales report. On the economic calendar, we’ll get updated on the latest Purchasing Managers’ Index (PMI) prints, existing home sales, Federal Open Market Committee (FOMC) minutes, and the much-anticipated core Personal Consumption Expenditures Price Index (PCE) read on inflation.

This week's data releases

Monday	U.S. market holiday; China loan prime rates
Tuesday	Federal Reserve Bank of Philadelphia Nonmanufacturing Business Outlook Survey, S&P Global PMIs, existing home sales; Canada retail sales and CPI; Eurozone and U.K. flash composite PMI; Germany ZEW Financial Market Survey and PMI; France PMI; au Jibun Bank Japan Manufacturing PMI®
Wednesday	U.S. FOMC minutes and existing home sales; Germany CPI and ifo Institute Business Climate Index; Italy CPI; Australia Wage Price Index; Singapore CPI
Thursday	U.S. initial jobless claims and fourth-quarter gross domestic product (GDP); Eurozone final Harmonised Index of Consumer Prices; Turkey interest rate decision
Friday	U.S. personal income and spending, Implicit Price Deflator for Personal Consumption Expenditures, University of Michigan Index of Consumer Sentiment; Germany final GDP; Japan CPI; Brazil Extended National Consumer Price Index 15; Mexico GDP and economic activity; Colombia interest rate decision

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Equity duration is the cash-flow weighted average time at which investors can expect to receive the cash flows from their investment in a company’s stock. Long-duration stocks include fast-growing technology companies, including those that may not pay any dividends in their early years, while short-duration stocks tend to be more mature companies with higher ratios to dividend to price.

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

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

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

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.

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

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

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

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

The 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.

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.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

Short interest is the number of shares that have been sold short and remain outstanding. Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price. Short interest often is seen as an indicator of current market sentiment. Rising short interest signals that investors have become more bearish. Falling short interest signals that they have become more bullish.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

Profit factor investing considers the gross profit of an investment divided by the gross loss (including commissions) for the entire trading period. This method is used to assess the amount of profit per unit of risk, with values greater than one indicating a profitable system.

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

Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset. 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.

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.

Core inflation is measured by the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, also known as the core PCE 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.

The Federal Reserve Bank of Philadelphia Nonmanufacturing Business Outlook Survey is a monthly survey of non-manufacturers in the Third Federal Reserve District, , which includes Pennsylvania, New Jersey, and Delaware. Participants indicate the direction of change in overall business activity and in the various measures of activity at their firms, including new orders, sales or revenues, employment, prices, and capital expenditures. Respondents also provide their assessments of general business conditions over the next six months.

S&P Global Purchasing Managers’ IndexTM (PMI) surveys provide monthly indicators that track economic trends in more than 40 countries and regions, including the Eurozone.

S&P Global Flash Composite PMIs are produced by S&P Global. The flash estimate is based on around 85% of total PMI survey responses each month and is designed to provide an accurate advance indication of the final PMI data for a particular country or region.

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

The au Jibun Bank Japan Manufacturing PMI^® is a purchasing managers’ index compiled by S&P Global from responses to monthly questionnaires sent to purchasing managers at about 400 manufacturers. The panel is stratified by detailed sector and company workforce size, based on contributions to Japan’s gross domestic product.

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

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

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

The Australia Wage Price Index, published by the Australian Bureau of Statistics, measures changes in the price of labor, unaffected by shifts in the labor force, hours worked, or employee characteristics.

The Singapore Consumer Price Index, published monthly by the Department of Statistics Singapore, measures average price changes over time of a fixed basket of consumption goods and services commonly purchased by resident households. It measures price movement (i.e., change in prices) but not absolute price level at a point in time.

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

The Implicit Price Deflator for Personal Consumption Expenditures, also known as the PCE deflator, is published by the U.S. Bureau of Economic Analysis and provides a price measure reflecting aggregate consumption inflation. Deflators are calculated by dividing the current-dollar value of an aggregate or component of a selected price index by its corresponding chained-dollar value, and then multiplying by 100. For all periods, the values of the deflator are very close to the values of the corresponding chain-type price index.

The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.

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

Brazil’s Extended National Consumer Price Index 15, also known as the IPCA-15, is published by the Instituto Brasileiro de Geografia e Estatística, tracks prices paid by families in the metropolitan areas of Belém, Fortaleza, Recife, Salvador, Belo Horizonte, Rio de Janeiro, São Paulo, Curitiba, Porto Alegre, and also the Federal District and the municipality of Goiânia.

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

The S&P SmallCap 600^® Index seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq.

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

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 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.

The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000^® Index, which represents approximately 7% of the total market capitalization of the Russell 3000^® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell^® is a trade mark 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.

 

RJIM23-0103 Exp. 6/21/2023

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Feb. 13, 2023: Is this the pivot that counts?

Global markets may finally be starting to take more hawkish central bank messaging to heart. Consequently, the pivot that counts could be coming in market expectations, not monetary policy.

“A lot of the data that has come in over the past few weeks has been stronger than expected, and it’s finally starting to cause a repricing of market expectations relative to the U.S. Federal Reserve,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “This is necessary progress, and remaining more defensive still makes sense in this environment where there’s still a lot of uncertainty around a wide range of macroeconomic events.”

A series of central bank officials reiterating that rates need to remain higher for longer has helped move the market closer to what the Fed has been saying, Orton said. Last week, Fed Governor Christopher Waller indicated the Fed was prepared for a long fight to curb inflation and that the disinflation process likely would take time, perhaps more time than markets expected. That took some wind out of the sails of the “everything rally” that has dominated so far in 2023.

“I have been surprised by the equity market’s ability to shrug off very clear messaging from the Fed,” Orton said. “Instead it has pushed the narrative that ‘immaculate disinflation’ — that is, falling inflation without a rise in unemployment — will lead to rate cuts in the back half of the year and largely avoid adverse economic outcomes from the rate-hiking cycle.” This has led to one of the largest divergences in the past decade between market internals and fundamental macroeconomic trends. One reason that Orton said he has remained cautious in the near term is because this divergence ultimately needs to unwind for the market to sustainably move higher. This focus is starting to change, but more work needs to be done to unwind some of the rally in the highest-duration, lower-quality companies that have surged this year, he said. Fixed income has corrected more than equities, which he said further raises the question of why many of the biggest-gaining stocks should remain generally supported. Rallying on a dovish central bank pivot and lower discount rates is one thing, but if bonds have given a lot of that trade back, Orton said that’s a shaky edifice to stand on. Lackluster earnings and uninspiring forward guidance from many of these companies further highlight the risks to this part of the market now.

Earnings season also is proving to be a double-edged sword. Overall results have been weaker than expected and guidance momentum has touched its lowest level since 2010. Full-year 2023 earnings-pershare (EPS) projections are now below 2022’s level ($222.10 versus $222.80) and continue to move lower toward Orton’s expected range of $215 to $220. But the market has been resilient in the face of these declining projections and he said the gradual decline in estimates should ultimately help to build a floor for the market. The market has also taken negative news in stride, something Orton said we need to see for a durable bull market. In fact, the market has rewarded positive earnings surprises more than average and punished negative earnings surprises much less than average. And while guidance has largely been negative, management teams have expressed a general level of comfort with their consumer base and haven’t raised any red flags. Meanwhile, net profit margins continue to move lower, something Orton said is worth following over the next few weeks. The blended net profit margin for the S&P 500 Index for the fourth quarter stands at 11.3%. That’s below the 5-year average of 11.4%, below the previous quarter’s net profit margin of 11.9%, and below the year-ago net profit margin of 12.4%. In particular, margins have come down in some of the companies that have rallied the most in information technology and communication services, and valuations in the big winners year to date also look like they may have moved too far, too fast.

“While my outlook is less than sanguine in the very near term, it’s worth noting some reasons for optimism within the broader economy,” Orton said. “Critically, we’re still not seeing any major cracks in the jobs market and wage growth is finally outpacing inflation for the bottom 50% of earners.”

Yet this, too, is a double-edged sword, since it gives the Fed cover to keep its foot on the brake, but at the very least it supports the notion of a soft-ish landing. Additionally, one major bank noted that consumer spending among its customers accelerated in January with credit and debit card spending per household increasing 5.1% year over year compared to 2.2% in December. While consumer deposit levels across all income groups declined slightly and have been trending down since April 2022, they remain significantly elevated versus pre-pandemic levels. That said, lower-income consumers certainly face headwinds that include elevated living costs, and growth in spending for lower-income consumers was weaker than for others. But even for the lowest income cohorts, the data broadly suggests consumers still have solid cash buffers and borrowing capacity to support future spending.

Orton’s playbook: Continue to lean into quality and small caps

Uncertainty remains high, and Orton said he continues to favor remaining more defensive until the market can start to converge around the guidance that has been provided by the Federal Reserve. Interestingly, he said, there seems to have been a negative correlation between the inherent risk of an asset and the amount of retracement that it’s sustained over the past week following the non-farm payrolls report. This doesn’t seem like a sustainable equilibrium, especially if the Consumer Price Index (CPI) comes in hotter than expected. Leaning into quality has been a winning trade up until the past few weeks, and Orton said he expects this to continue as the market normalizes some of the speculative outperformance this year. Within this context, he said he believes growth at a reasonable price (GARP) will remain strong. Decreasing probabilities of a hard landing have supported growth more broadly, but he said more reasonably valued growth companies are likely to lead in a higher-for-longer rate environment.

Orton said small caps remain his highest conviction opportunity in the market, with the Russell 2000^® Index still ahead of the S&P 500 even after a tough go last week (+9.1% versus +6.7% year to date, respectively). Earnings expectations continue to come down for small-cap companies, but this helps to establish a floor for a sustainable longer-term rally. Should small caps sell off on a hotter than expected CPI print, Orton said he believes that could be a good point at which to increase exposure. Valuations, particularly for higher-quality small-caps (i.e., the S&P SmallCap 600^® Index), remain near historical lows and are baking in a hard landing not seen since the 2008 recession. Flows into small caps remain anemic and could provide strong tailwinds should they pick up. From a technical perspective, small caps never made a new low in October, unlike the S&P 500 and Nasdaq Composite Index. The recent break above the November highs could see a further break to the August highs, which he said would have longterm significance.

What to watch

This week is likely to remain volatile with some key inflation data coming via the Consumer Price Index on Tuesday and the Producer Price Index on Thursday. The inflation reads will be accompanied by a heavy slate of Federal Reserve speakers, which will keep the focus on the path of rate hikes and whether we see the market continue to play catch-up in its rate projections. The January CPI is expected to show a +0.5% month-over-month rise with energy prices higher again. It’s also that time of year for hedge funds and investment managers to disclose their portfolio positions.

This week's data releases

Monday	Japan gross domestic product; Australia business confidence
Tuesday	U.S. CPI, National Federation of Independent Business Small Business Optimism Index; U.K. jobless claims; Eurozone unemployment
Wednesday	U.S. retail sales, industrial production, Mortgage Bankers Association Weekly Applications, and Empire State Manufacturing Survey; U.K. Consumer Prices Index and Producer Price Index; Eurozone industrial production, trade balance
Thursday	U.S. housing starts, initial jobless claims, continuing claims, Producer Price Index, and Federal Reserve Bank of Philadelphia Manufacturing Business Outlook Survey; Japan trade balance; Australia unemployment; China new home prices
Friday	U.S. Import/Export Price Indexes; U.K. retail sales; France consumer price index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from 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.

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.

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

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

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

Equity duration is the cash-flow weighted average time at which investors can expect to receive the cash flows from their investment in a company’s stock. Long-duration stocks include fast-growing technology companies, including those that may not pay any dividends in their early years, while short-duration stocks tend to be more mature companies with higher ratios to dividend to price.

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.

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

Correlation is a statistic that measures the degree to which the prices of two securities, sectors, asset classes, or other financial metrics move in relation to each other.

Retracement is a technical term that describes a minor pullback or change in the direction of a stock, index, or other financial instrument. Retracements are considered to be temporary and do not signal a shift in the larger trend.

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.

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

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

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset. 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.

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

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

The National Federation of Independent Business’s Small Business Optimism Index surveys small and independent business owners on 10 equally weighted and seasonally adjusted variables, including their hiring, investment, and inventory plans, as well as on their economic expectations, assessment of the state of the economy, labor market, credit conditions, and earnings trends. The monthly change of each variable contributes proportionally to the overall monthly change in the index.

The Mortgage Bankers Association Weekly Applications covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.

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

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

The U.K. Producer Price Index, published by the Office for National Statistics, tracks changes in the prices and goods bought and sold by U.K. manufacturers, including indices of materials and fuels purchased (input prices) and factory gate prices (output prices).

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

The U.S. Import/Export Price Indexes are published by the Bureau of Labor Statistics and contain data on changes in the prices of nonmilitary goods and services traded by the United States and the rest of the world.

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

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

The S&P SmallCap 600^® Index seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

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

The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000^® Index, which represents approximately 7% of the total market capitalization of the Russell 3000^® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ^© LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell^® is a trade mark 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.

 

RJIM23-0086 Exp. 6/13/2023

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Feb. 6, 2023: This market needs to get past denial

Let’s get straight to the point, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“Whether or not you agree with the impressive rally so far in 2023, it’s a perfect reminder of the challenges around market timing and why it’s so important to remain invested in the market,” he said. “While anyone hiding out in short-term Treasuries or money market funds is getting the best yield in over a decade, they’re missing out on the benefits of broad capital markets exposure — which, by the way, can provide the same yield but also the opportunity to participate in market rallies. You need to stay invested to capture those capital market gains.”

At the start of the year, one of the key questions Orton asked was “What could go right?” Risks were skewed to the right tail and we’re seeing that play out. He said he did not, however, expect to see such a sharp turn. FOMO — fear of missing out — has quickly taken over and the general low-quality nature of the rally bears following closely. Volatility, short interest, and leverage are the three best-performing factors year to date while momentum has crashed and profitability quickly went out of favor, with some well-known names jumping from 40% to more than 100%. And perhaps the best example of the speculative fervor is the jump in short-dated call-buying, including a surge in popularity of zero days to expiration options. All of this highlights why Orton said he believes caution is warranted in the near term. The market is still at odds with the U.S. Federal Reserve (Fed) as it continues to price rate cuts in 2023. Even the blockbuster jobs report and improved Institute for Supply Management Services ISM^® Report on Business® weren’t enough to convince the market that higher for longer might mean just that.

Consequently, Orton said he remains quite content leaning into higher-quality companies, particularly growth at a reasonable price (GARP), which has continued to outperform the market. “You don’t need to be chasing extremely high growth to be successful,” he said. Small caps remain Orton’s highest-conviction opportunity in the market, with the Russell 2000® Index up 12.8% year to date versus 7.9% for the S&P 500 Index, and higher-quality small caps (i.e., the S&P SmallCap 600® Index) up even more (+13.4%). Small-cap valuations remain attractive on an absolute and relative basis while asset flows have barely turned and can provide strong support for further upside.

Markets often hear what they want to hear when central bankers speak, which might help to explain the reactions we saw last week to the Fed and European Central Bank meetings. Both Fed Chairman Jerome Powell and ECB President Christine Lagarde promised more hikes to come. But Powell’s relaxed reaction to easing financial conditions saw markets initially shift to pricing in lower rates. Lagarde promising another 50-basis (bp) hike didn’t stop traders from hearing a dovish message, either. Even the mammoth jobs print on Friday was barely enough to get investors to consider that the rationale for two rate cuts in the back half of this year is tenuous at best. The U.S. economy added more than 500,000 jobs in January (a massive upside surprise), bringing the unemployment rate to a five-decade low with improving labor force participation. Even if you take out the seasonal adjustment, which was larger this year, the figure was still way above expectations. Orton said it also was encouraging to see that wage growth continues to moderate. Average hourly earnings rose 0.3%, as expected in January, and the annual reading slowed to 4.4% from 4.8% in December, supporting the recent deceleration. Wage growth, however, is still running way above its pre-pandemic average and there is further work to be done before Orton suspects that the Fed will be satisfied. All of this supports the Fed’s view of holding the federal funds rate at 5.25% through 2023, not cutting rates.

Earnings season hasn’t been great, but guidance has been good enough once again to push back against the notion of an impending earnings apocalypse, Orton said. The stronger than expected jobs market and improving consumer sentiment might also provide some insulation from margin weakness going forward. With 50% of the S&P 500 by market cap having reported results, the blended earnings decline stands at -5.3% versus the -3.3% consensus as of Dec. 31. Analysts also have continued to lower 2023 earnings estimates, which now stand at $224 but still represent annual growth of 3.0%. Orton said he believes we’re getting pretty close on the downward revisions to properly reflect the slower growth environment in which we’re operating. Perhaps most disappointing were the results from the mega-cap tech companies, which mostly posted downward surprises. Interestingly, information technology, communication services, and consumer discretionary are the largest contributors to the earnings decline, while healthcare is one of the strongest contributors and is reporting the largest positive surprise. But healthcare is one of the worst-performing sectors year to date while the former three are among the top performers. This is a good reminder of the rotation taking place in the market, Orton said, but he still remains somewhat skeptical because it’s not clear that earnings have actually bottomed in tech and communication services. Guidance wasn’t inspiring, certainly not inspiring enough to justify a 15% rally in the Nasdaq Composite Index, which has been driven completely by multiple expansion.

“While I might be skeptical about the speed of the current rally, that doesn’t mean I’m bearish on the market,” Orton said. Markets are purging themselves of the of the inflation theme of last year, digging into the notion that the Fed will both cut rates in the back half of 2023 and at the same time avoid a hard landing. But he said not all three conditions can happen concurrently. The Fed has broadcast that rates will be higher for longer, and he said he sees no reason to doubt this as consumer surveys, Job Openings and Labor Turnover Survey (JOLTS) data, and plunging jobless claims all point to a labor market that remains tight.

“Markets are incredibly overbought right now and bullish sentiment is stretched,” he said. “There will be some indigestion as the market moves past denying the reality that the Fed will keep at it. The gap in interest rate pricing between the market and the Fed needs to be closed for the market to sustainably move higher.”

Once that happens, however, Orton said he believes the underlying fundamental conditions will support additional upside, albeit more balanced between growth and value with a focus on quality companies. With valuation dispersion near record highs and clear winners and losers over the past earnings season, he said the environment going forward should be supportive for active managers.

The January employment report featured a consensus-shattering 517,000 payroll gain, breadth across industries, the lowest unemployment rate since 1969, and a surge in aggregate hours worked that will contribute to gross domestic product (GDP). The overall tone was a shot across the bow of those who believe the Fed is heading toward an early termination of tightening or pivot to rate cuts, Orton said. An array of indicators pointed to a tight labor market around the turn of the year including lower jobless claims, higher openings, resilient consumer confidence, a rebound in the ISM services data, and now the strong January jobs report.

What to watch

Fed Chairman Jerome Powell is scheduled to speak at the Economic Club of Washington D.C. on Tuesday, which could be an opportunity to push back against the dovish interpretation of last week’s Federal Open Market Committee meeting. We may also see some political noise. The Biden administration postponed Secretary of State Antony Blinken’s upcoming trip to Beijing after detecting a Chinese surveillance balloon over U.S. nuclear sites, and the president will deliver his State of the Union address on Tuesday. Earnings season slows down a bit, but there are still some key releases to watch.

This week's data releases

Monday	Germany Consumer Price Index and factory orders; Eurozone retail sales; Australia inflation gauge and retail sales
Tuesday	Australia interest rate decision; Germany and Spain industrial output
Wednesday	U.S. wholesale inventories; Japan and South Korea balance of payments; Poland and India interest rate decisions
Thursday	U.S. initial jobless claims; Sweden interest rate decision; China aggregate financing and money supply; Mexico interest rate decision; Brazil, Mexico, and Taiwan consumer price indices
Friday	U.S. University of Michigan Index of Consumer Sentiment; U.K. GDP and industrial output; China Industrial Sector Producer Price Index, Consumer Price Index, and balance of payments; Canada unemployment; Japan Producer Price Index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from 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.

Tail risk describes a form of portfolio risk associated with the increased possibility that an investment will move more than three standard deviations from the mean in a normal distribution. Left tail risks refer to unusually large losses. Right tail risks refer to unusually large gains.

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.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

Short interest is the number of shares that have been sold short and remain outstanding. Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price. Short interest often is seen as an indicator of current market sentiment. Rising short interest signals that investors have become more bearish. Falling short interest signals that they have become more bullish.

Leverage investing refers to the use of debt to enhance returns from an investment.

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.

Profit factor investing considers the gross profit of an investment divided by the gross loss (including commissions) for the entire trading period. This method is used to assess the amount of profit per unit of risk, with values greater than one indicating a profitable system.

An option is a financial instrument based on the value of underlying securities such as stocks. An options contract offers its buyers the opportunity to buy or sell — depending on the type of contract they hold — the underlying asset.

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

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

A short call is an options position used by an investor who believes that the price of the asset underlying the option will drop. The call option gives the buyer of the option the right to purchase underlying shares at the strike price before the contract expires. The buyer is effectively betting on a fall in the price of the security underlying the option. Consequently, short calls reflect a bearish outlook.

Zero days to expiration options (0DTE) are options contracts due to expire within a day. 0DTE options offer the potential to make a quick return, but the window of opportunity is small, and 0DTE buyers must act quickly to execute the moves they are contemplating.

The Services ISM^® Report on Business^® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

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

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

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

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

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

A consensus estimate is a forecast of a public company’s projected earnings 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 multiple, sometimes referred 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.

Multiple expansion occurs when a stock’s multiple rises, in some cases faster than the stock’s fundamental value. Multiple expansion creates arbitrage opportunities for investors who have bought the stock at the lower multiple value.

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.

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

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

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

A balance of payments (BOP), also known as the balance of international payments, summarizes all transactions completed between individuals, companies, and government organizations in one country with individuals, companies, and government organizations outside that country in the rest of the world over a defined period, such as a quarter or a year.

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

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

The Taiwan Consumer Price Index, released monthly by the National Statistics Bureau of the Republic of China (Taiwan), tracks prices paid by Taiwanese consumers for a wide range of goods and services.

The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.

The China Industrial Sector Producer Price Index (PPI) is released monthly by the National Bureau of Statistics of China and reflects the trend and level of prices change when the products are sold for the first time. The survey of industrial producers covers the prices of industrial products in 40 major industrial categories and more than 1,300 basic categories.

The China Consumer Price Index (CPI), released monthly by the National Bureau of Statistics of China, measures changes over time in prices of goods and services in eight categories and 268 basic divisions covering consumption by urban and rural residents, including food; tobacco and liquor; clothing; residential costs; household articles and services; transportation and communication; education, culture, and recreation; healthcare; and other articles and services.

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

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

The S&P SmallCap 600^® Index seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

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

The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000^® Index, which represents approximately 7% of the total market capitalization of the Russell 3000^® Index.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ^© LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell^® is a trade mark 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.

 

RJIM23-0075 Exp. 6/6/2023

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