March Markets in Focus

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Markets in Focus

Timely analysis of market moves and sectors of opportunity

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March 27, 2023: This market still doesn’t hear the Fed

The U.S. equity market continues to be characterized by high levels of dispersion and disconnection.

Dispersion over the past few weeks has been incredibly high with nearly a 22% month-to-date difference between the best- and worst-performing sectors in the S&P 500 Index: communication services +8.78% versus financials -12.99%.

“It’s pretty astounding that despite a crisis of confidence in global financials as well as the increased concern about a recession and the negative impact of tightening credit conditions, U.S. equities managed to end last week higher with nine of 11 sectors in the green, including financials,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “That said, the dominance of megacap tech is really what has held the market together in March and frankly for the year so far. “

The Nasdaq Composite Index is up nearly +17% year to date versus +3.85% for the S&P 500 while the Dow Jones Industrial Average is in the red (-1.10%). Orton said it’s interesting that virtually nothing seems to be able to slow the rotation trade back into technology, not even the continued affirmation from U.S. Federal Reserve (Fed) Chairman Jerome Powell that higher for longer means just that. To be sure, tech — and mega-cap tech in particular — has been a big beneficiary of the flight to safety as investors hunt for stocks with steady revenue, durable secular growth themes that can hold up in a downturn, and strong balance sheets. This sounds similar to the drivers of outperformance following the COVID market crash, except that then interest rates were essentially 0% and earnings were accelerating sharply.

Frankly, this was the most uncertain Fed rate decision in recent memory.

“I can’t help but worry that the ballast of mega-cap tech is precarious with forward price-to-earnings ratios for most of these names back to the highest points of 2022,” Orton said. “To be fair, many of these names were taken to the woodshed last year and there were some very compelling opportunities. But with the market continuing to price multiple interest rate cuts in back half of this year, many of these names are already priced for perfection heading into earnings season. This persistent disconnect with the Fed and questions about earnings resiliency are just a few of the many reasons why I advocate for remaining defensive and leaning into quality.”

Another key reason why Orton said he believes it makes sense to remain defensive is that volatility is here to stay. Just think about the rollercoaster that the market narrative has been on in less a single quarter:

Recession fears (first few weeks of January)
Soft-landing optimism (late January through mid-February)
The “No Landing”/reheating economy (mid-February to early March)
Fears of a bank crisis in the United States and Europe (early March to last week)
Modest optimism that the banking crisis is contained to a few idiosyncratic institutions (last week)

All of this has contributed to volatility, particularly a surge in interest rate volatility. The rapid re-pricing of Fed expectations around these changing narratives has led to a 227-basis point (bp) round trip for the two-year yield from Feb. 2, following the report of stronger than expected economic data, through Friday. That, Orton said, is nothing short of spectacular. And a continued disconnect between what the Fed is broadcasting (i.e., no rate cuts in 2023) and what the market is pricing (i.e., multiple rate cuts in 2023) will almost certainly keep volatility elevated across asset classes, he said.

The sharp decline in two-year U.S. Treasury yields
has been extreme. Is it overdone?

Source: Bloomberg, as of 3/24/23

Economic data was overshadowed last week, Orton said, and it’s worth highlighting because it continued to paint a picture of a resiliency that once again calls into question the market’s aggressive pricing of rate cuts. Consider initial jobless claims, which remained low in a tight labor market. Specifically, unemployment insurance filings fell slightly in the week that ended March 18, a snapshot that includes the period following the failures of Silicon Valley Bank and Signature Bank. Low jobless readings in 2023 reinforce that banking stress comes amid persistent worker shortages, not bloated payrolls. Layoff announcements concentrated in the technology and financial sectors have not yet translated to broad-based job shedding in the rest of the economy. Save for a blip higher in early March — in large part attributable to school break-related filings in New York — the claims trend has been stable-to-lower this year. Friday’s S&P Global Flash U.S. Composite Purchasing Managers’ Index (PMI) report also painted a more optimistic picture for continued growth in the face of banking woes and high interest rates. The data was collected from March 10 through March 23, amid the banking crisis, and it showed improvement in manufacturing and strong service-side output as well as upbeat expectations for both services and manufacturing.

Going forward, Orton said flexibility is going be required as we navigate incoming data and digest any additional fallout from the banking crisis. The collapse in two-year yields has been breathtaking, and rate cuts in the coming months are now priced as a virtual certainty. This all just seems overdone, he said. Given the relative strength of recent economic data, he said rate cut expectations are going to have to normalize at some point soon, and then the two-year yield would snap back closer to the funds rate. This will lead to a reversal in some of the rotation that has occurred in equity markets and remains a key reason why Orton said it doesn’t make sense to chase the run in tech or to start to bottom-fish in areas that have been beaten down. With U.S. short-term interest rates still above 4%, he said maintaining higher levels of cash and cash equivalents and being ready to be opportunistic makes sense as the dust settles.

“I also believe that the market will change how it reacts to activity data,” he said. “Rather than continuing to see bad news as good news, I expect future downside surprises to lead equity markets to price in a higher likelihood of recession. All of this tells me to continue leaning into quality, which has proved to be quite resilient during the recent volatility and throughout past times of turbulence in the market.”

Key takeaways from the Federal Open Market Committee

It’s no surprise that the Fed hiked by 25 bps and that no changes were made to the median projection for where interest rates will end the year. But what stood out to Orton was the theme of uncertainty.

“Frankly, this was the most uncertain Fed rate decision in recent memory,” he said. “That uncertainty is perhaps why the language on further ‘ongoing’ increases in rates was altered to ‘some additional policy firming may be appropriate.’ “

Chairman Powell expressed confidence in the overall health of the banking sector, but also repeatedly stressed that tighter credit conditions could do some of the Fed’s work — in his view, possibly the equivalent of 25 to 50 bps of further tightening. Powell also cautioned that it was too soon to understand the net impact of banking sector strains, but Orton said he agrees with Powell’s general assessment that the Fed will likely need to “do less.” While acknowledging credit headwinds, Powell also bemoaned excessive inflationary pressures and emphasized that there would be a “long” and “bumpy” path back to 2% inflation. In particular, he noted the lack of evidence of disinflation in non-housing services.

“It’s clear that the Fed is telling us its work isn’t done yet,” Orton said, but that officials are paying attention to financial stability concerns and that tighter financial conditions brought via the banking debacle could impact the need for further rate hikes. Even so, they still see that rates need to remain higher for longer to combat inflation, and Orton said it’s worth noting that the dot plot’s projected federal funds rate for the end of next year did not move lower.

“Clearly, the recent turmoil hasn’t increased the chance for rate cuts, at least not yet, and that is where the disconnect with the market remains the widest,” he said. “Similar to the start of the year, the market refuses to believe that higher for longer means just that.”

What to watch

Banks likely will dominate the headlines this week. The central banks of Mexico, South Africa, Colombia, Thailand, and Kenya are all expected to follow the Fed with quarter-point interest rate increases next week. We also will get a raft of European inflation data and the U.S. Personal Consumption Expenditures (PCE) Price Index.

This week's data releases

Monday	China industrial profits; ifo Institute Business Climate Index for Germany
Tuesday	U.S. wholesale inventories and U.S. U.S. Consumer Confidence Survey^®; Brazil central bank meeting minutes
Wednesday	Australia consumer price index (CPI); South Korea Consumer Sentiment Index
Thursday	U.S. initial jobless claims; Inflation data from Spain and Germany; Italy unemployment; Mexico, Colombia, and South Africa interest rate decisions; Brazil inflation report; Australia job openings
Friday	U.S. consumer income, Implicit Price Deflator for Personal Consumption Expenditures, and University of Michigan Index of Consumer Sentiment; Euro-area CPI estimate and unemployment; Inflation data from France and Italy; Germany unemployment; U.K. gross domestic product; Caixin China General Manufacturing Purchasing Managers Index; Poland CPI; Brazil unemployment

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

Diversification does not ensure a profit or guarantee against loss.

RJIM23-0179 Exp. 7/27/2023

March 20, 2023: Volatility is here to stay

A lot has transpired over the past week, and while it’s too early to make bold predictions, one thing is obvious: Volatility is running high, with more to come.

“There are a lot of risks in the market, so being defensive remains the game plan,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “This is not a market where it makes sense to be jumping into until we have more news and see where the dust is going to settle.”

Still, there are a few developments — both positive and negative — that Orton said are worth noting. On the positive side, the rush by central banks to restore confidence and prevent the liquidity crisis from gaining steam highlights that systemic risk is manageable. Global central banks have gained great experience fighting fires since the Global Financial Crisis, and they have a wide toolkit to respond to liquidity dry ups like we’re seeing play out. While this has been a critical step to restoring confidence, the wave of liquidity isn’t yet lifting all boats. Poor liquidity and elevated volatility are making it difficult to invest, Orton said, but the broad de-risking will create opportunities.

“This play will unfold in many acts and it’s probably too early to be rushing to find gems in the rubble,” he said. “That said, this could end up being a positive environment for active management. I remain defensive as we head into the next act and can’t emphasize enough the importance of leaning into quality and ensuring that asset allocations are properly diversified and set up to weather what is sure to be an environment of elevated volatility going forward.”

Speaking of volatility, the move in yields over the past week has been staggering. The crash in two-year Treasury yields was the sharpest reversal in momentum ever and was close to a move of 15 standard deviations. Interest rate volatility surged well above the incredible levels reached during the March 2020 market crash. The repricing of expectations for future U.S. Federal Reserve (Fed) policy also has been epic. A little over a week ago, overnight index swap markets implied that the effective federal funds rate for the December Federal Open Market Committee meeting was above 5.5%. It has now fallen below 4% with more than 100 basis points (bps) of cuts priced for 2023! Orton said he believes this is premature as inflation is still too high, so he continues to expect the Fed to hike by 25 bps on Wednesday, perhaps even re-emphasizing that higher for longer means just that.

Interest rate volatility surged to the highest level since 2008

Source: Bloomberg, as of 3/17/23

Equity and foreign exchange volatility also jumped, but not as much

Source: Bloomberg, as of 3/17/23

“The Fed has never cut rates when core inflation is this high and unemployment is this low,” he said.

Equity volatility also has returned in force. There have been sharp reactions in measures of volatility that include volatility-of-volatility and volatility skew. That marks a notable change from last year, with the beta for the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) rising above a reading of 1.0 — indicating higher levels of volatility than in the broader market as represented by the S&P 500 Index — for the first time since the second quarter of last year.

And this pick-up in equity volatility has occurred amid a surprisingly benign backdrop for the indices. The S&P 500 has not seen a close-to-close down day of more than 2% year to date. In fact, the S&P 500 is only -3.3% off its month-to-date highs and remains up +2% year to date. The Nasdaq Composite Index is up +4% month to date and is up nearly +15% year to date. Last week, we saw one of the fastest rises on record in the growth-to-value ratio as the COVID playbook of tech and growth came back. Mega caps in particular have provided a ballast to the market, but Orton said he worries that they look quite stretched. Any breakdown in the largest names will put additional pressure on the market and further contribute to increased volatility.?

Growth vs. Value surged over the past few weeks…

Source: Bloomberg, as of 3/17/23

…and last week had one of its best weeks on record

...and last week had one of its best weeks on record

Source: Bloomberg, as of 3/17/23

One of the main reasons equity market volatility hasn’t surged is the strength of the mega-cap technology stocks. Just the six largest stocks have together contributed approximately 77% of the positive month-to-date returns for the S&P 500, and that is evident when looking at the extreme dispersion in performance across sectors. The market of stocks is underperforming the stock market, with the S&P 500^® Equal Weight Index trailing the cap-weighted S&P 500 by 468 bps in March. The sharp decline in rates has certainly helped sentiment around technology more broadly, but it’s the cash-rich balance sheets of these companies coupled with durable secular growth trends that have turned them into a perceived safety play. While these names are profitable and higher quality than the broader information technology and communication services sectors, Orton said he worries that sharp decline in rates has been overdone as well as declining earnings momentum for the group. On the flip side, it’s worth noting that energy has had an even rougher go than financials over the last week (and energy is the biggest underperformer year to date) as oil prices have collapsed by about $14 per barrel and recessionary fears have increased. The oil patch is getting close to some key technical levels, and Orton said further underperformance risks breaking the longer-term uptrend that has been in place since 2021.

From a positioning perspective, there are elevated risks due to the aggressive easing that has been re-priced into the market. Inflation is still too high, Orton said, and the actions of European Central Bank foreshadow that we’re likely to see the Fed similarly divorce monetary policy from the specific liquidity issues brought on by the failure of Silicon Valley Bank. That presents downside risks for longer-duration bond prices as well as equities. With U.S. short-term rates still above 4%, holding higher levels of cash and cash equivalents makes sense for investors looking to be opportunistic as the dust settles, he said. Within equities, quality has surged back after outperforming for most of last year. Quality has performed well throughout past times of turbulence in the market such as in 2008, 2020, and 2022, and with earnings season coming up in just a few weeks Orton said he expects to continue to see investors rewarding profitable companies with earnings stability and strong free cash flow generation.

“Healthcare stabilized last week, as expected, given an increased defensive rotation in the market, but I’m surprised not to see stronger performance,” Orton said. “I believe this sector looks attractive both in the United States and globally given its quality characteristics and insulation from the fears in the market right now. Banks to me are a falling knife, and while I believe that the moneycenter banks will ultimately be winners coming out of this, it’s too early and I would avoid bottom-fishing. It also presents a headwind to broader index strength until we can see a trustworthy recovery.”

Small caps have been trounced over the past few weeks as recession worries returned with a vengeance and the negative impact of regional bank exposure also weighed heavily. Orton said there’s not much positive to say but pointed out that the Russell 2000^® Index has been trying to hold its December lows. If the index breaks down further, Orton said he wouldn’t be surprised to see a retest of the June and October lows. For now, while valuations look attractive and already capture moderate to severe recessionary conditions, he said he wouldn’t want to jump in right here.

Global markets have held up better than the United States, and Orton said he continues to prefer emerging markets, particularly Asia excluding China. Indonesia, South Korea, Taiwan, and Thailand all posted positive performance last week across a diverse range of sectors and Orton said he believes that these countries can continue to outperform. They all benefit from the China reopening as well as from idiosyncratic economic growth drivers and a turn in the semiconductor cycle. International developed markets are a bit more challenged given their sensitivity to financials, and indices like the Financial Times Stock Exchange (FTSE) 100 Index, which held up well during uncertainty last year, face challenges given heavier weightings toward financials and energy.

The larger issue in the banking crisis

Almost every tightening cycle is associated with some crisis or shock to the system, and in hindsight the issues with Silicon Valley Bank were hiding in plain sight, Orton said. While the market remains concerned with additional fallout in the banking system, he said the larger issue is how the current banking crisis further accelerates the reduction of money availability in the U.S. economy. The U.S. Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices and the European Central Bank’s Bank Lending Survey already point to tightening credit conditions for large and small businesses, and Orton said banks are likely to tighten credit further because of this crisis. Banks outside of the top 25 account for approximately 38% of all outstanding loans and 67% of commercial real estate lending. Any pullback and tightening of credit will certainly have an impact on the economy, he said. Up to this point, economic growth has been more resilient than many expected due to monetary policy buffers from high accumulated savings, persistently supportive fiscal policy, and labor hoarding that delayed the impact of slower economic activity on employment, sentiment, and aggregate incomes. How the cracks emerging in the banking system offset these buffers will be key to how the economy ultimately lands.

While Silicon Valley Bank was unique with respect to the circumstances that led to its demise, it was a victim of the broader challenges still faced by unprofitable companies, Orton said. Silicon Valley Bank was a key supplier of financial services (both loans and deposit facilities) to the cash flow-negative Silicon Valley ecosystem. The rescue of the bank might have saved these companies in the short term, but it highlights how many of these companies remain unprofitable and have yet to reach a sustainable financial position. The combination of rising interest rates and elevated concern in the banking system will make it more difficult for these companies to raise fresh funding, and this likely will weigh on both private venture capital and public valuations. The fallout of this crisis also will weigh on the banking sector. There will be greater competition for deposits, which will weigh on net interest margins and bank earnings in the near to medium term, he said. Share buybacks also could be paused until the market stabilizes. All of this makes financials less appealing, particularly smaller and regional banks. From a technical perspective, the charts across the financial sector are all broken — including the money-center banks which Orton said he believes will be the ultimate beneficiary once the dust has settled — and so he said he would proceed with extreme caution.

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.

Definitions:
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.

Standard deviation is a measure of the dispersal or uncertainty in a random variable. For example, if a financial variable is highly volatile, it has a high standard deviation. Standard deviation is frequently used as a measure of the volatility of a random financial variable.

An overnight index swap applies an overnight rate index such as the U.S. dollar, federal funds or London Interbank Offered Rate (LIBOR) rates. Indexed swaps are hedging contracts in which one party exchanges a predetermined cash flow with a counter-party on a specified date. A debt, equity, or other price index is used as the agreed exchange for one side of this swap.

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%.

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 MOVE Index is a measure of U.S. interest rate volatility that tracks the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries.

The JP Morgan Global Currency Volatility Index follow aggregate volatility in currencies throughout the Group of Seven nations, also known as the G7. The G7 is an informal bloc of advanced democracies that meet annually to coordinate global economic policy and discuss other transnational issues. G7 countries include the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom.

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

Duration incorporates a bond’s yield, coupon, final maturity and call features into one number, expressed in years, that indicates how price-sensitive a bond or portfolio is to changes in interest rates. Bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations.

Volatility of volatility is a concept that sees volatility not as constant, but as something that varies over time. The Chicago Board Options Exchange (CBOE) VVIX, or volatility of volatility index, measures the volatility of the price of the VIX and is an indication not only of the volatility of the S&P 500 but also of how quickly market sentiment changes.

Skew, also known as volatility skew, is the difference in implied volatility between out-of-the-money-options, at-the-money options, and in-the money options. Skew is affected by sentiment and the supply and demand relationship of particular options in the market, and provides information on whether fund managers prefer calls or puts.

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.

“Out of the money” (OTM) describes a put or call contract that only contains extrinsic value. Such options have a delta — that is, the ratio that compares the change in the price of the underlying asset to the corresponding change in the price of its derivative — of less than 0.50. An OTM call option has a strike price higher than the market price of the underlying asset. An OTM put option has a strike price lower than the market price of the underlying asset.

“At the money” refers to what happens when an option’s strike price is identical to the current market price of the underlying security.

“In the money” refers to an option that possesses intrinsic value and presents a profit opportunity due to the relationship between the strike price and the prevailing market price of the underlying asset. An in-the-money call options means the option holder can buy the security below its current market price. An in-the-money put option means the option holder can sell the security above its current market price.

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

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.

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

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.

A falling knife is a saying used in investing to describe a rapid drop in the price or value of a security. The admonition against trying to catch a falling knife is a way of saying that an investor should wait for a price to bottom before buying a security that could either rebound or lose all of its value if the company issuing it goes into bankruptcy.

The U.S. Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices is a survey of up to 80 large domestic banks and 24 U.S. branches and agencies of foreign banks. The Federal Reserve generally conducts the survey quarterly, timing it so that results are available for the January/February, April/May, August, and October/November meetings of the Federal Open Market Committee. The Federal Reserve occasionally conducts one or two additional surveys during the year. Questions cover changes in the standards and terms of the banks’ lending and the state of business and household demand for loans. The survey often includes questions on one or two other topics of current interest.

The European Central Bank’s Bank Lending Survey Bank Lending Survey provides information on the lending policies of euro area banks and complements existing statistics on loans and bank lending rates with information on loan supply and demand for enterprises and households. The survey addresses issues such as credit standards for approving loans, as well as credit terms and conditions applied to new loans to enterprises and households. It also asks for an assessment of loan demand. Its objective is to enhance the Eurosystem’s knowledge of bank lending conditions in the euro area. The survey provides input for the European Central Bank Governing Council’s assessment of monetary and economic developments, on which it bases its monetary policy decisions.

A net interest margin compares the net interest income a bank generates from credit products like loans and mortgages with the outgoing interest it pays holders of savings accounts and certificates of deposit. Expressed as a percentage, net interest margin is an indicator of profitability indicator that reflects the chances of a bank thriving over the long term.

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 75% 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 Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The Financial Times Stock Exchange (FTSE) 100 Index tracks the 100 largest blue-chip stocks by market capitalization traded on the London stock exchange and is viewed by many investors as a proxy for the performance of the U.K. stock market.

The Russell 1000^® Growth Index measures a growth-oriented subset of the Russell 1000 Index, which tracks approximately 1,000 of the large-sized capitalization companies in the United States equities market.

The Russell 1000^® Value Index measures a value-oriented subset of the Russell 1000^® Index, which tracks approximately 1,000 of the large-sized capitalization companies in the U.S. equities market.

The Russell 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.

RJIM23-0172 Exp. 7/20/2023

March 13, 2023: Move fast and things break

Last week’s drama is set to continue as investors digest the implications of Silicon Valley Bank on the broader financials sector and economy as well as the Consumer Price Index (CPI) report on Tuesday.

“There are obviously going to be concerns,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “Does this spread more widely? I believe the actions of the U.S. Federal Reserve, the Federal Deposit Insurance Corp., and the Treasury over the weekend help eliminate many questions, but the market is still in a sell first, ask questions later posture.”

U.S. equities had their worst week of the year last week, starting with a hawkish turn from U.S. Federal Reserve (Fed) Chairman Jerome Powell during his congressional testimony and accelerating into the collapse of Silicon Valley Bank. A well-known regional banking exchange-traded fund fell by -16% on the week, its worst showing since March of 2020, and the weakness in regional banks also contributed to meaningful underperformance across small caps, which have a larger weight at the index level to this part of the market (the Russell 2000® Index was down -8%).

While so much attention is understandably focused on the fallout and potential implications of Silicon Valley Bank, Orton said he believes an equally important story is the massive move in rates that occurred last week. The yield on two-year Treasuries jumped by 20 basis points (bps) to over 5% after Powell warned of the possibility of a 50-bp hike later this month as data has continued to show a resilient economy and a tight labor market. But just days later, the 10th-largest U.S. bank by assets had been shuttered, partially a result of restrictive monetary policy, taking two-year yields down by nearly 50 bps! Federal fund futures are pricing in a peak rate of below 5.3% now — that was about 5.44% on Friday but climbed above 5.6% after Powell spoke on Tuesday.

“These are massive moves,” Orton said, “and I can’t help but believe we’re going to see a continuation of this extreme volatility this week given some critical data releases such as the CPI and Producer Price Index that will factor into the ultimate Fed rate hike decision.”

Don't overlook the significant move in yields

Source: Bloomberg, as of 3/10/23

One of largest three-day moves in two-year yields since 1987

Source: Bloomberg, as of 3/10/23

Before diving into the specifics of Silicon Valley Bank, Orton said it’s important to take a step back and assess where we are in the current cycle.

“When the Fed started the most aggressive monetary tightening cycle in more than 40 years, I fully believed it set out to break things,” he said. “And to be honest, some things needed to be broken after more than a decade of artificially low capital costs further accelerated by trillions of dollars injected into the system through COVID relief. Too much money leads to a misallocation of capital, and the beneficiaries of this misallocation — think SPACs (special purpose acquisition companies), crypto tokens, NFTs (non-fungible tokens), and buy now/pay later financing that flourished in 2020 and 2021 have been brought back to earth.”

These parts of the market needed to be broken, Orton said, and up until last week the collateral damage appeared to be well contained. Economic data has generally held up much better than expected despite the rapid tightening of financial conditions over the last year. Corporate earnings haven’t imploded and companies have continued to invest in growth. But last week was a reminder that it’s incredibly difficult not to have any collateral damage on the Fed’s quest to bring down inflation. The question is whether this will remain contained and how does this impact the path of the Fed going forward?

Orton said he believes the Fed stepped down to a 25-bp hike in February because it wanted to wind down its rate-hike campaign, leaving rates at a higher plateau and providing some flexibility as the lagged impact of monetary policy started to move through the economy. Hotter than expected economic and inflation data over the past few months complicated this move, even pointing to a possible re-acceleration of the economy in January. But Friday’s jobs data painted a mixed picture, with the rise in unemployment and lower than expected wage growth partially offsetting the impact of elevated headline payroll growth for the market. Challenger Job Cut Report layoff data released last Thursday provides a more immediate snapshot of the current employment situation, rising to levels are that more consistent with a slowing economy. February credit card data also suggests that while spending remained resilient, the January re-acceleration was short-lived. Add in the turmoil from Silicon Valley Bank and Orton said he believes that risks are much more balanced for a 25-bp hike in March, barring any strong upside surprises from the CPI data on Tuesday.

I believe it makes sense to let the dust settle before adding to small caps right now, but the longer-term opportunity remains attractive.

Defensive positioning certainly worked well last week, and Orton said he continues to advocate for maintaining a core defensive bias, specifically leaning into quality. Increased rate volatility has whipsawed sectors, but quality has held up well and he said he expects this to continue as investors reward stable earnings growth, profitability, and increasingly care about not overpaying for growth. Dividend growth has also stabilized since getting hit hard on a relative basis in January as the “everything rally” led to momentum crash.

“I believe it’s important to tread carefully in the near term, particularly with respect to financials,” he said. “Eighty percent of the financial sector made a four-week low last week, and I would be very mindful in playing a potential selling climax, even for the money center banks with strong balance sheets that were thrown out with the bathwater. It’s also worth pointing out that while rates have sharply reversed course, they’re still meaningfully higher over the past month and there is still more normalization that needs to take place in the higherduration parts of the market.”

While small caps were challenged, Orton said he does not believe any of the news from last week changes the long-term opportunity set. If anything, he said, it re-affirms his preference to remain active and to lean into higher-quality small-cap companies. In particular, small-cap financials and healthcare companies were taken to the woodshed last week. More than 16% of the Russell 2000 sits within financials (with nearly 10% of that is in banks) and the Silicon Valley Bank turmoil led to significant losses.

“I don’t believe there are systemic risks, and this too shall pass,” he said. Similarly, small-cap healthcare was hit hard as investors worried about funding and liquidity for biotech, life sciences, and technology companies that burn through cash. “I believe it makes sense to let the dust settle before adding to small caps right now, but the longer-term opportunity remains attractive.”

Why Silicon Valley Bank appears to be an outlier

One of the key features of aggressive monetary tightening is that its impact can play out in a decidedly nonlinear fashion, Orton said. The questions people are asking now are, does the implosion of Silicon Valley Bank herald a more systemic bout of financial risk? And will this prompt a similar change of tune from the Federal Open Market Committee?

“Critically, this is not 2001 nor 2008 nor 2020,” Orton said. “Most large and regional banks have much more diversified deposit bases than Silicon Valley Bank. While it can’t be ruled out that a handful of other banks could face concerns if their investor or depositor confidence takes a hit, I don’t believe this is systemic.”

The forceful action of policy makers on Sunday evening is important, he said, and reflects a multi-pronged approach both to alleviate concerns related to uninsured deposits at Silicon Valley Bank and Signature Bank, a New York-based bank closed by regulators over the weekend after a run on deposits, while also easing liquidity pressures more broadly among depository institutions. At first glance, Orton said the proposed measures appear to be a formidable prescription to help resolve funding risk, especially deposit flight.

“I believe these targeted, but forceful measures will avert the need to alter the course of monetary policy more broadly,” he said. “It also reinforces that the selloff in the money center banks feels very overdone. But it’s worth noting that all it took was one big blow and a couple of days for an important bank to crumble.”

Silicon Valley Bank was unique in a few different respects, he said, with the key difference being a very concentrated depositor base in venture capital (VC) and startup companies. The venture capital industry was a key beneficiary of a 0% interest rate policy as well as of the explosion of tech and crypto firms that arose in the aftermath of the great COVID money drop. Silicon Valley Bank’s close connection with the VC world can be directly seen in its parabolic loan growth starting in 2020. Silicon Valley Bank also was somewhat unique in how it then managed its liabilities through its use of available-for-sale securities — which are purchased with the intent of being sold before they reach maturity — versus held-to-maturity securities, which are bought to be held until they mature and thus are not as useful if their owners need cash in the short term. With the sharp increase in rates over the past year, VC-backed startups burned through cash and pulled money from their accounts because VC funds had slowed investment, pressuring deposits at the bank. Last week, the bank sold some of its bond holdings at a loss to raise money needed to cover the withdrawals, then planned to sell stock to raise more capital. But those steps instead shook depositor and investor confidence, leading to a run on the bank and the collapse of the stock sale. While Silicon Valley Bank is a unique example of bad interest rate hedging and the risks of having a precariously narrow customer base, the sudden implosion of a large bank is a big data point signaling that all these interest rate hikes are starting to take effect.

Beyond banks, Orton said perhaps this is wake-up call to watch for pressures on non-bank financials and unlisted alternatives, both of which benefitted from a decade of quantitative easing with repressed interest and plentiful liquidity. Every business cycle has a credit cycle, he said, and perhaps rather than going through the banks as would normally be the case, this one is working through the lightly regulated and less transparent non-bank financial sector. The current hiking cycle and slowdown in economic growth has exposed fragile capital structures, particularly in segments where there has been rapid growth and financial innovation. Private equity, private credit, and direct lending all should be watched closely as the impact of the hiking cycle works its way through the economy.

What about European banks?

Orton has had a favorable outlook on European financials and he said one key question to ask is: Are there any financial channels of spillover risk beyond pure sentiment? To be sure, many banks globally, including European banks, have unrealized losses on their bond portfolios. But beyond that, he said he sees few spillover channels into European banks because:

European banks have more traditional business models. There are also few new banks and less competition from money markets.
European bank bond portfolios held as available for sale are marked to market and reflected through the Common Equity Tier 1 ratio, a regulatory comparison of a bank’s capital to its assets.
Excess liquidity is very high in the Eurozone: Banks have €3 trillion in excess liquidity and the European Central Bank is at an earlier stage in liquidity withdrawal.

Global markets outperformed again last week, though financials weighed heavily on indices. Orton said he believes the relative insulation overseas from the Silicon Valley Bank-related uncertainty can continue to lead to outperformance in the near term.

What to watch

Buckle up, Orton said. It’s going to continue to be a bumpy ride with a wide range of reports this week on inflation, employment, consumer sentiment, and global macroeconomic trends.

This week's data releases

Monday	India consumer price index; Mexico industrial production
Tuesday	U.S. CPI; U.K. unemployment; Australia household spending and business confidence
Wednesday	U.S. Producer Price Index, retail sales, Empire State Manufacturing Survey, and Mortgage Bankers Association Weekly Applications; Eurozone industrial production; Sweden consumer price index; Japan central bank minutes; U.K. budget; China retail sales and industrial production
Thursday	U.S. initial jobless claims, building permits, housing starts, and Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey; European Central Bank interest rate decision; Japan industrial production; Indonesia interest rate decision
Friday	U.S. industrial production, University of Michigan Index of Consumer Sentiment; Eurozone final Harmonised Index of Consumer Prices; Russia interest rate rate decision; Brazil unemployment

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.

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.

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.

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

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

The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the 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.

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

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

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.

A special purpose acquisition company (SPAC) is a “blank check” shell corporation designed to take companies public without going through the traditional IPO process. SPACs allow retail investors to invest in private equity type transactions, particularly leveraged buyouts.

An NFT, which is short for non-fungible token, is a unique cryptographic asset, including images, other works of art, or property rights, on a blockchain with unique identification codes and metadata that distinguishes it from any other asset and ensures that it cannot be replicated.

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.

Available for sale securities are bought with the intent of being sold before they reach their maturity.

Held-to-maturity securities include bonds and forms of debt such as certificates of deposit that are purchased to be owned until maturity. Thus, they are not useful for investors who need cash in the short term.

Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet.

The Challenger Job Cut Report, published by the outplacement and business and executive coaching firm Challenger, Gray & Christmas, is a monthly sector-by-sector account of announced job cuts and hiring plans by U.S.-based employers.

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.

Mark to market is a method of measuring the fair value of assets, liabilities, or other accounts that can fluctuate over time. Mark to market strives to provide a realistic appraisal of a company or institution’s current financial circumstances based on current market conditions. During volatile markets, however, mark-to-market measurements may not accurately represent an asset’s true value in an otherwise orderly market.

Common Equity Tier 1 (CET1) is a component of Tier 1 capital that is primarily common stock held by a bank or other financial institution. Eurozone banks are held to minimum CET1 ratio requirements, which compare a bank’s capital against its assets.

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

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

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 Sweden Consumer Price Index, published by Statistics Sweden, measures the average price trend for the entire private domestic consumption based on prices consumers actually pay and serves as the standard measurement of compensation and inflation calculations in Sweden.

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 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 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 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.

RJIM23-0148 Exp. 7/13/2023

March 6, 2023: Whistling past the graveyard

Economic data continued to surprise to the upside last week, pushing rates higher and keeping the possibility open for a 50-basis point (bp) hike at the next U.S. Federal Reserve (Fed) meeting. The 10-year U.S. Treasury yield briefly crossed 4% and the two-year yield is still marching toward 5%, yet equities posted gains for the week, with higher-duration sectors like information technology and communication services outperforming. These are signs of “misplaced strength in the market,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“I can understand seeing more cyclical sectors like materials and industrials outperforming on the back of stronger global economic data, particularly as many industry groups within these sectors have posted decent earnings and outlooks,” he said. “But I can’t help but think that investors are whistling past the graveyard when it comes to equities, particularly the most rate-sensitive sectors with negative earnings momentum and more challenged near-term outlooks.”

Investors continued to get confirmation that the rate environment will remain higher for longer, and that the risks might still be skewed to the upside of what’s priced in, Orton said. On Thursday, Fed Governor Christopher Waller struck a hawkish tone, saying the Fed was datadependent, and if data continues to come in hot, he supports raising rates more than currently projected “to ensure that we do not lose the momentum that was in place before the data for January were released.” There is still a wide disconnect between higher-duration equities and the reality of a “higher for longer” environment, and consequently Orton said he continues to favor maintaining a defensive bias and not chasing the market higher.

My caution on the markets in the near term should not be confused with pessimism. In fact, I would argue that there is quite a lot to be optimistic about.

While the most difficult adjustments to interest rates and inflation were left behind in 2022, the repricing that took place in February in reaction to hotter than expected inflation and economic data is meaningful nonetheless, Orton said. The market came into this year pricing a terminal rate below 5% along with 100 basis points of cuts in the second half of this year and 200 basis points of cuts in 2024. The market is now pricing in a September peak in interest rates at 5.4%, nearly a percentage point above the current effective federal funds rate, and traders are preparing for the possibility of the Fed returning to jumbo rate hikes, with overnight index swaps pricing in about 31 basis points of tightening later this month. Expectations for rate cuts in 2023 have also nearly disappeared. Yet the Nasdaq Composite Index is up nearly +13% year to date versus +6% for the S&P 500 Index. The Nasdaq 100 Equal Weighted Index also is up more than 10%, highlighting that it’s not just the huge gains in a handful of tech heavyweights that are propelling the index, but is widespread across the most rate-sensitive parts of the market. To be sure, there are many companies that are leaders in industries with strong secular growth tailwinds that were thrown out the bathwater last year and have deservedly recovered. But for many other lower quality companies, Orton said a normalization still needs to occur to reflect the reality of a higher-for-longer rate regime. “This is a key reason why I believe that active management will continue to add value going forward, just like it did in 2022,” he said.

“It’s also worth noting that my caution on the markets in the near term should not be confused with pessimism,” Orton said. “In fact, I would argue that there is quite a lot to be optimistic about,” including that:

Markets have finally neutralized overly optimistic and overbought conditions that resulted from the January rally while managing to hold the 200-day moving average. There is strong improvement in the price action within industrials, materials, and financials.
Investors haven’t overreacted to bad news and are penalizing earnings misses less than average. The impending earnings apocalypse that so many strategists were expecting at the end of last year still looks incredibly unlikely, Orton said, especially given the resiliency of economic data.
Earnings per share (EPS) estimates have continued to move lower and are much closer to reflecting an environment of slower growth: EPS estimates for the first quarter of 2023 have decreased by -5.7% over the last two months while full-year 2023 estimates declined -3.3% to $222.80. This is the largest decline in the annual bottom-up EPS estimate during the first two months of a year since 2016 and gets pretty close to Orton’s estimate of $215 to $220.
The strength of the U.S. dollar looks to be contained, and while a stronger jobs report this week could be a catalyst higher, Orton said he believes such gains are unlikely to sustain. After all, the recent improvements in activity have not been a U.S.-only phenomenon (recent Caixin China General Manufacturing Purchasing Managers Index and Eurozone inflation data both printed stronger than expected), and higher yields more broadly may continue to encourage structural flows away from the U.S. toward the rest of the world.

From a positioning standpoint, Orton said he continues to believe that investors should be leaning into higher-quality companies. Quality has held up reasonably well all things considered, but going forward he said he expects investors to reward stable earnings growth, profitability, and to start caring again about not overpaying for growth. Within this context, he said he believes growth at a reasonable price (GARP) will remain strong, since 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.

Similarly, he said, small caps still look attractive and have outperformed nicely with the Russell 2000^® Index up +9.7% year to date (and the S&P SmallCap 600^® Index up +9.9%) versus a gain of +5.7% for the S&P 500. Small-cap fundamentals have the opportunity to outperform large-cap stocks on an earnings and margin basis for the first time in a while, Orton said, 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 also are coming in better than expected, which is not the case for the S&P 500. Russell 2000 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., the S&P SmallCap 600), 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, he said.

What the Fed really cares about is not whether the jobs market is just strong or weak, it’s how that strength feeds into increased wage pressures.

Globally, Orton said he continues to like emerging markets but expects continued volatility in the short term as U.S. 10-year yields may continue rising. That said, better than expected economic data, including from the recovery in China, coupled with low investor positioning make buying weakness attractive in emerging markets. Being active is only way to properly play emerging markets, he said, and within the complex he said he continues to favor the Asia Pacific excluding-China group (i.e., Indonesia, Philippines, Taiwan, and Korea), which has been outperforming. Tailwinds from the China re-opening as well as strength from Europe and the United States should continue to support a turnaround in EPS and margin growth. Within international developed markets, Orton said he still likes European banks and believes the strong earnings momentum will continue, especially with better than expected economic data and rising real rates.

Looking closer at February’s Institute for Supply Management Manufacturing Purchasing Managers’ Index^® survey, it’s clear that pent-up demand for services still appears to have legs, and the latest data show the job market may remain too hot for the Fed’s comfort. The employment component of the manufacturing survey pointed to the strongest growth since December 2021, and price pressures remained heady at an index reading of 65.6 (with readings higher than 50 indicating that the manufacturing economy is generally expanding). Some 84.9% of service providers reported prices paid were the same or higher in February, with 16 of 17 services industries reporting an increase in prices. This is a particular problem, Orton said, because the inflation in the non-housing service sector is what the Fed is focused on bringing down.

Jobs data will be key this week

Source: Bloomberg, as of 1/31/23

What to watch

It’s all about jobs data this week, starting with the Jobs Openings and Labor Turnover Survey (JOLTS) and payrolls service provider ADP’s National Employment Report^™ reading on Wednesday. Weekly jobless claims follow on Thursday, and then comes nonfarm payrolls on Friday.

“What’s really going to move the needle this week is going to be on Friday,” Orton said. “And I think it’s not even so much what the actual jobs number is going to be but rather what average hourly earnings are. That’s because what the Fed really cares about is not whether the jobs market is just strong or weak, it’s how that strength feeds into increased wage pressures.”

We’ll also hear from Fed Chairman Jerome Powell in congressional testimony on Tuesday and Wednesday. Following an abundance of other Fed officials’ remarks, including the latest hawkish comments from Governor Waller, Orton said he expects Powell to demonstrate high conviction to remain resolute and “keep at it” to conquer inflation. However, without February jobs data and the Consumer Price Index in hand, Orton said it may be too early for Powell to provide a concrete near-term policy prescription. A drop in auto sales, mixed consumer confidence, and a contractionconsistent manufacturing ISM survey spoke to some normalization in February. But the services ISM supported the economic reacceleration narrative, as new orders picked up for the largest sector of the economy.

This week's data releases

Monday	U.S. durable goods; Eurozone retail sales; China trade balance
Tuesday	U.S. wholesale inventories and consumer credit; Germany factory orders; Japan trade balance
Wednesday	U.S. Job Openings and Labor Turnover Survey, Mortgage Bankers Association applications; Germany retail sales, industrial production; Eurozone gross domestic product (GDP) and employment; China Consumer Price Index and Industrial Sector Producer Price Index
Thursday	U.S. initial jobless claims; Japan money supply, GDP, producer price index, household spending and Bank of Japan policy meeting; U.K. industrial and manufacturing production; Mexico consumer price index
Friday	U.S. employment report; U.K. trade balance; Germany consumer price index; France trade balance

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.

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. 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.

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.

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.

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.

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.

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

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

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.

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.

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 bottom-up EPS estimate is an aggregation of the median EPS estimates for all the companies in an index.

The Caixin China General Manufacturing Purchasing Managers Index (PMI), compiled by IHS Markit, tracks supply and demand, manufacturing production, output, new orders, employment, and other measures of economic activity in China’s manufacturing sector.

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.

Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset, sector, or index. It typically is measured on a quarterly or monthly basis. Investors and others look at the direction of fund flows for indications about the health of specific securities and sectors or the overall market.

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.

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.

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

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

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation. Once adjusted, it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor. A real interest rate reflects the rate of time preference for current goods over future goods. For an investment, a real interest rate is calculated as the difference between the nominal interest rate, which is not adjusted for inflation, and the inflation rate.

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

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

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

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.

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 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 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 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 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 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 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 Nasdaq 100 Equal Weighted Index is an equal weighted version of the Nasdaq 100. It includes 100 of the largest non-financial stocks listed on the Nasdaq stock market based on market capitalization and is rebalanced quarterly.

The Russell 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.

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RJIM23-0137 Exp. 7/6/2023