“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
The market is set to report strong performance for the first half of 2024, but skeptical investors remain on the sidelines.
Weaker economic data partly reflects the lagging impacts of monetary policy, and investors have expected the U.S. economy to moderate from its robust post-COVID pace.
Periods where the market is overbought at an index level — like the one we’re in now — have previously lasted for long stretches of time.
The market looks set to notch a strong first half of the year. The S&P 500 Index’s year-to-date return is more than 15%.1 Inflation is finally starting to provide reasons to be optimistic that the recent moderation is sustainable, and consequently 10-year U.S. Treasury yields have come down 45 basis points from their peak in April. Earnings growth has also exceeded expectations for the last two quarters, and global growth has been better than feared.
“Given this positive backdrop, it’s fair to ask why there are still so many skeptical investors sitting on the sidelines,” said Matt Orton, CFA, Chief Market Strategist for Raymond James Investment Management.
Some of the hesitancy may be due to concerns about narrowed market breadth. The S&P 500® Equal Weight Index is up only 5.5% year to date, underperforming its capitalization-weighted counterpart by nearly 10%. The top five companies in the S&P 500 Index have contributed 100% of its quarter-to-date gains, and only 27% of S&P 500 Index constituents are outperforming the index quarter to date. Weakness also is appearing in cyclical leaders such as industrials, financials, and materials. “Any signs of widening market breadth that we saw during earlier earnings seasons have been eroded recently,” Orton said.
“There are important concerns that shouldn’t be ignored, but there’s no reason to expect the general trend of narrowness to reverse suddenly,” he said. He added that market environments like this one have previously lasted for long periods, and it will be important to see how this narrowness reverses.
“Sure, the S&P 500 could lag while the equal-weighted index could surge,” Orton said. “But they could both go nowhere for a while. Or they could both continue to do well, but surging breadth could take over and help lagging stocks improve their performance.” He said that the market doesn’t have to crater for breadth issues to be resolved.
Internals aren’t great, but they’re not that bad
S&P 500 Index year-to-date
Source: Bloomberg; as of 6/22/24.
“For the skeptics out there, it’s certainly OK to believe that we’re approaching some sort of mean reversion or normalization,” Orton said, “but don’t let that obscure the broader backdrop in which we’re operating.” He believes that markets are overdue for some sort of consolidation, and the extreme dislocations that internals have experienced over the past few weeks have the potential to normalize.
“Any consolidation should be viewed within the context of a bull market,” he said. “In fact, it’s high time that more investors started believing that we’re indeed in a bull market, and missing bull markets is incredibly expensive.”
Orton said there are opportunities for investors to find value in pockets of the market. Within the bull market context, he believes that downside shouldn’t be viewed as something that needs to be avoided at all costs — rather, it should be embraced as an opportunity to consider putting capital to work at more attractive levels.
“I believe in staying invested when the economy is strong; that’s how you build wealth,” he said. “There are still too many skeptics out there to say we’re at or near peak optimism.”
Some skeptics have pointed to weaker economic data as a harbinger of something much worse. “While U.S. economic data has indeed slowed of late, I view this as a cooling rather than deterioration,” Orton said. “To be sure, the “May’s Advance Monthly Retail Trade Survey indicated some belt-tightening among consumers, but in the big picture, recent data shows personal consumption remains healthy and back to tracking its pre-pandemic trend in inflation-adjusted terms.”
Orton said that a moderation from the robust economic reports that followed the COVID recession has been expected for quite a while, and it partly reflects the lagging impacts of monetary policy and inflation. “High interest rates and inflation disproportionately impact lower-income households, which mainly spend on goods,” Orton said. “Conversely, higher-income households have pushed spending on services above the pre-pandemic trend.” He expects that increased services activity will continue to support growth in consumer spending this year, or at least help it avoid becoming problematic for the economy or market.
“We certainly do need to monitor leading indicators to gauge whether a more severe downturn in consumer spending might be coming down the road,” Orton said. These indicators include the labor market details revealed by the Conference Board when it shares its survey results on Tuesday. “Although survey participants have noted that jobs are less plentiful, they are still not hard to get,” he said. Orton’s base case is for this to continue, which could corroborate messages from other labor market data released this month: A job market that is rebalancing, but not falling apart.
Orton said some of the short-term extremes in the market suggest it’s more likely than not that we will see some consolidation earlier this summer. “I expect we’ll see some rotation beneath the surface and some real money coming back into the market that is focused on the underlying fundamentals instead of chasing momentum,” he said.
Sticking with momentum…for now. The biggest winners at present have been the top contributors to the market since late 2022, but Orton said that other companies have also been big winners without making the same outsize impact on return contributions due to their smaller market capitalization. “Take a look at the list of stocks in your favorite momentum factor exchange-traded fund right now, and you’ll see that they’re all high-quality companies,” he said. “Momentum underperformed last week and might remain a bit shaky into the quarter-end rebalance period, but I think investors should still consider having an overweight exposure. Earnings could help keep those names pushing higher.” Once earnings season begins, Orton said it would be very constructive for market breadth if the larger banks and industrials complex reported strong results.
Revisiting “AI 2.0.” “The weakness we saw in semiconductor companies at the end of last week has not signaled the end of the artificial intelligence (AI) trade,” Orton said. “Rather, it’s a needed break from the torrid rally.” He believes that the turn in utilities, electric equipment, mining companies, and other ancillary trades on this theme offer an interesting entry point for investors who feel like they missed the rally earlier this year. “It has been encouraging to see software companies rally nearly 10% over the past few weeks following positive earnings results as they play catch-up with semiconductor companies,” Orton said. “The key to success remains leaning into quality and investing in the most durable growth. There are some clear winners in this space, and there are many posers that are rightfully being brought back to reality.”
What is happening to small caps? “It was nice to see small caps hold up last week, but it doesn’t change the concerning trend of small caps declining when interest rates are down,” Orton said. “This tends to be bearish because it signals increased recession risk, and I’ve been commenting for the past few weeks that the equity market is increasingly more focused on growth than on rates.” Orton thinks the market may be over-reacting to the slowing growth story and that the data is simply normalizing to trend levels.
“The Russell 2000® Index is underperforming the S&P 500 Index by almost 9% this quarter and 15% year to date,” Orton said. “Underperformance since the start of 2023 is now almost 30%, and the three largest S&P 500 Index companies each have market capitalizations that are more than the entire Russell 2000® Index.” Mid-cap companies are performing in line with the S&P 500® Equal Weight Index, and Orton said that sector performance at the lower end of the market capitalization scale does not suggest recessionary positioning. “I tend to think the risk–reward tradeoff still looks interesting for small-cap companies, especially if the narrative settles on a soft landing and some additional clarity is provided on the inflation front.” He suggests that investors consider building a small exposure that can be increased if clarity is provided.
Inflation will be in focus this week: On Friday, the U.S. Department of Commerce Bureau of Economic Analysis will release personal income and outlays data for May. The report will include the Personal Consumption Expenditures (PCE) Price Index, excluding food and energy — core PCE, the U.S. Federal Reserve’s preferred gauge of inflation — and it is expected to show a deceleration from April. The second estimate of first-quarter U.S. gross domestic product (GDP) will be released on Thursday. And Conference Board consumer confidence data will provide an updated snapshot on perceptions around the labor market. Orton said that initial unemployment claims and continuing unemployment claims are always important to follow.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of June 21, 2024.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
Definitions
The Advance Monthly Retail Trade Survey, published by the U.S. Census Bureau, provides an early indication of sales of retail and food service companies. It is used by the Federal Reserve Board to anticipate economic trends.
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%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
The Conference Board calculates indices and administers surveys, such as the Conference Board Consumer Confidence Index® and the CEO Confidence survey, which measure various sentiments related to the United States economy.
Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.
Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.
The U.S. Department of Commerce Bureau of Economic Analysis issues reports known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.
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.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
Mean reversion refers to the statistical tendency of data to rise or fall toward its long-term average over time.
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.
The iShares® MSCI USA Momentum Factor ETF tracks an index composed of large- and mid-cap U.S. stocks that exhibit price momentum.
The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.
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.
Overweight describes a portfolio position in an industry sector or some other category that is greater than the corresponding weight level in a benchmark portfolio.
The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
A soft landing is a cyclical slowdown in economic growth that avoids a recession. A hard landing is a significant economic slowdown or downturn, that could include a recession, following a cycle of rapid growth.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-565150 Exp. 10/24/2024
A small number of stocks have dominated the S&P 500 Index, but concentration tends to increase during bull markets.
Stocks that are working may be masked by elevated dispersion at the index level.
Investors should remain careful about putting new money to work in the very short term and may want to consider waiting for some consolidation — either through price or time — to increase their exposure to the market.
Many reasons have been put forth to dismiss the current bull market, including the U.S. Federal Reserve’s “higher for longer” policy, elevated index concentration, and expensive valuations. Despite the negativity, some investors are finding reasons to stay positive.
“All this pessimism has missed the positive fundamental underpinnings of this market and, frankly, the bearish thesis has simply been wrong,” said Matt Orton, CFA, Chief Market Strategist for Raymond James Investment Management. “I certainly appreciate the risks that are present, and perhaps the narrowness of what is working right now reflects those risks.”
The top 10 stocks in the S&P 500 make up over 34% of the index, the highest level on record (the previous highest level was 32.87% in 1963).1 But Orton said that concentration tends to increase during bull markets, and the 1963 rally continued for years before a meaningful correction occurred.
“Despite the current set of risks, I remain optimistic while reiterating that investors should be careful about putting new money to work in the very short term,” Orton said. “Instead, consider waiting for some consolidation — either through price or time — to increase exposure to a market that I believe will broaden.”
Earnings growth has already broadened, and Orton said that it is accelerating higher across a wide range of sectors and industries; he sees some good values beneath the surface. “Yields are coming down and finally look to be breaking the upward trend that has persisted for most of this year,” Orton said. “Usually this is a prerequisite for increasing market breadth, and perhaps we’ll start to see a change beneath the surface once second-quarter earnings season kicks off next month.”
Orton said that for now, investors would do well to remain positive but vigilant and focused on capturing downside opportunities that might appear in the coming weeks.
“It’s interesting that we’ve seen yields break lower in the United States but breadth hasn’t followed,” Orton said. “The dollar has also remained firm, and credit spreads are widening a bit.” He said that last week was a perfect example of how the market of stocks, represented by the S&P 500® Equal Weight Index, is disconnected from the stock market, reflected by the capitalization-weighted S&P 500 Index.
While the small number of market leaders is anomalous, Orton said that investors need to ask what is driving these gains. “Here the fundamentals come back into play. There’s reason to be optimistic around artificial intelligence (AI) integration following the long-anticipated unveiling of consumer-facing AI capabilities at a key consumer hardware company, and plenty for investors to look forward to following a key semiconductor company’s rosy forward guidance last week,” he said.
“Meanwhile, there are many stocks working beneath the surface, they’re just masked at the index level by incredibly elevated dispersion,” Orton said. “The elevated level of dispersion is actually a signal to me that investors are hyper-focused on fundamentals and key growth drivers. And it’s hard to ignore the high-quality growth at the top of the market.”
Orton believes that this market should not be mistaken for one that is flying too close to the sun and about to meet its impending doom.
Orton said that it’s important to continue owning what’s working in the market. “The dominance of the mega-cap trade is perfect evidence of this: These are high-quality companies with strong, long-term secular growth tailwinds,” Orton said. However, he said it is important not to overlook the increase in earnings breadth that has been playing out across sectors. “Broadening earnings growth could ultimately help drive broader price performance,” he said, highlighting these larger themes:
Industrials oversold. Nearly every sector outside of technology and communication services has lagged over the past few weeks, but Orton was surprised to see the industrials sector continuing to struggle. “This sector has been a source of relative strength over the past year or so, generally outperforming the S&P 500® Equal Weight Index,” Orton said. Sentiment has turned quickly, and he believes that industrials are exposed to many of the tailwinds coming from AI along with the geopolitical tensions affecting the aerospace and defense industry.
Waiting on Europe. Europe is still grappling with its European Union parliamentary elections and the call for snap elections from French President Emmanuel Macron. “The damage to French markets has been significant, and until we get through the French elections, this is a dip that I wouldn’t be chasing right now,” Orton said. In his view, adverse election outcomes could mean a higher cost of equity and downside risks for banking sector profitability, but he said that it depends on the exact policy agenda.
Crouching China, rising India. Asset allocation is critically important over the long term, but so is country allocation. “$1 million invested in the MSCI China Index on December 31, 2013, would be worth only $935,400 as of June 14, 2024. An identical investment in the MSCI India Index would be worth $2.59 million over the same period,” Orton said. “India has been the only major compounder outside of the U.S. over the longer term, and we’re at the precipice of another strong secular growth phase.”
Orton believes that the country has a long runway for an infrastructure build-up, seeing it in the early phase of a capital expenditure upcycle that could last for 9 to 10 years. “There is also government and geopolitical support for scaling manufacturing in select sectors like electronics, autos, pharmaceutical, and textiles over the next decade as companies look to shift capacity away from China,” he said. There could be some near-term consolidation as investors digest the election results and the government forms a budget, but Orton thinks investors should consider any downside as a good entry opportunity.
The focus remains on monetary policy: Central bank decisions are due from the People’s Bank of China, Bank of England, Reserve Bank of Australia, and Swiss National Bank this week. The yen is near three-decade lows versus the dollar, which will be in focus when the Japan Consumer Price Index data is released on Friday. French politics will keep traders busy as they gauge risks to financial stability; last week was the worst for the nation’s bonds since the 2011 European debt crisis.
Retail sales data for the United States will be released this week along with industrial production figures for May. Earnings results from homebuilders will also be noteworthy because they could provide an additional view into the state of the consumer and persistently elevated mortgage rates.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of June 14, 2024.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.
The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.
A credit spread is the diff erence in yield between a U.S. Treasury bond and another debt security with the same maturity but diff erent credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% diff erence in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.
Dispersion of performance refers to how much the returns of individual stocks vary from their collective average. It increases as the spread between highs and lows widens.
The Japan Consumer Price Index (CPI), 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.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over Risk Information:
Secular growth trends persist regardless of other trends in the market.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The MSCI India Index measures the performance of the large and mid-cap segments of India’s market by tracking approximately 85% of the Indian equity universe.
The MSCI China Index captures large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings.
M-561695 Exp. 10/17/2024
