Markets in Focus

Timely analysis of market moves and sectors of opportunity

May 31, 2022: Bear market rallies are seductive. Proceed with caution.

Last week ended on a high note with strong gains throughout the week bringing U.S. equities into positive territory for the month of May. The Dow Jones Industrial Average surged 6.2% and snapped an eight-week decline, its longest losing streak since 1932, while the S&P 500 Index climbed 6.5% and the Nasdaq Composite Index jumped 6.8%. At the same time, last week also was the first time in a while that Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, advocated putting money to work given the market’s incredibly weak sentiment and stretched negative internals.

“It was a great reminder of why it’s so important to stay the course and put money to work even when it might feel painful,” Orton said. “Even though price action was encouraging, I emphasize caution with respect to chasing the market higher. I think now is the time to start to use downside again but more opportunistically to fill in asset allocation holes to get exposure to the market. What we saw last week confirms that we are in a bottoming process, but I expect to see a lot of chop in the near term.”

Quote Image
Since we aren’t in a bull market, we shouldn’t be positioned like we are in one.

Orton said it is important to remember that bear market rallies are very seductive as they pull you in but rarely do we see V-shaped recoveries without some exogenous catalyst such as dramatic policy changes from the U.S. Federal Reserve. Financial conditions are still tight, there’s still tremendous uncertainty with respect to inflation, and Orton said the market still needs to show it can absorb bad news and not totally fall apart.

“We can’t have total wipeouts in companies that miss earnings and good news needs to be rewarded,” he said.

But he said that if we continue to see strong improvement in breadth with sentiment moving off apocalyptic lows, there is scope to see a new uptrend develop as the market works through some of its current challenges. And Orton said there are opportunities from an asset allocation standpoint.

Still, last week’s price action was a reminder of why investors should avoid getting sucked into the rapidly changing market narrative, Orton said. At the start of last week the American consumer was all but dead, but results from a variety of retailers, ranging from a luxury department store to dollar store chains, showed wealthy and not-so-wealthy consumers were out spending in force. Orton has long maintained that the American consumer is doing well, even with inflation running hot, especially in energy and food. A strong labor force has provided insulation from these headwinds and Orton said he expects overall consumption to remain healthy until the labor market begins to crack. Savings are being drawn down meaningfully, he said, so it’s critical for the labor market to remain strong. So far, he noted, high-frequency data is corroborating that it is.

“So what areas of the market look interesting right now?” he said. “I might be stating the obvious, but since we’re not in a bull market, we shouldn’t be positioned like we are in one.”

That means maintaining a core defensive bias with a focus on higher dividends and dividend growth; high quality; and active fixed income, Orton said. This has worked well on a relative basis year to date, he said. However, if there are ups and downs during the bottoming process, Orton said the downs provide an opportunity to marginally add to higher beta parts of the market, such as high-quality software, to keep up when the market pops. In the very short-term Orton said he also is more neutral on small caps and is thinking that tactically reducing underweights to the space could help take advantage of any potential recovery.

A turn in equities, but will it hold?
Breadth and daily moving averages (DMA) in the S&P 500

A turn in equities, but will it hold? Breadth and daily moving averages (DMA) in the S&P 500

Breadth improved last week and for the first time since March, 20% of stocks were at four-week highs. A sustained turn would
confirm a new trend, Orton said. Meanwhile, he said he wouldn’t be surprised to see some short-term weakness, but markets overall
are still far from overbought.

Source: Bloomberg, as of 5/27/2022.

Last week’s rally wasn’t surprising

Even after the market strength last week, only 26% of the stocks in the Russell 3000® Index are trading above their 200-day daily moving average (DMA). There has been tremendous damage done to the market, which Orton said can provide a tailwind going forward. However, he noted, “it’s rarely a smooth ride.”

In addition to seeing continued gains in the market, Orton said he’s looking for high-yield credit spreads to stop widening — something that happened last week, “but they need to hold,” he said — for financial conditions to stop tightening, and for CEO confidence to start to improve or at least to moderate.

“If all of that starts to happen, I think that sets us up well very nicely for the second half of the year,” he said.

Orton on small caps: Neutral for now. Skeptical longer-term.

Orton has advocated maintaining an underweight small-cap position over the past eight months, notably due to the inherent lower-quality characteristics for smaller companies. And while he said he still views the Russell 2000® Index as an anti-quality index over the longer term and thus more convex to an economic downturn, he said he does think it looks tactically well-positioned for a relief rally.

“I still don’t like small caps in the long term,” he said. “There are a lot of headwinds for small caps and I still see them as an anti-quality pocket of the market, but they’re just so oversold. I’ve never seen positioning as negative in small caps as I have now. There’s been no flows into the space, and with flows starting to move into large-cap technology, small caps could be the next recipient of any dollars in motion. The valuation gap right now between small caps and large caps is the widest since the tech bubble burst, so that’s an area to be very tactical about and maybe add a little bit on the margin without increasing positioning too dramatically.”

Orton said the Russell 2000 ticks all the boxes from a short-term tactical perspective because it is:

  • More domestically focused, and thus faces less of a headwind from a strengthening dollar;
  • More tied to the economic cycle, where Orton said he believes recessionary fears are currently overdone; and
  • Incredibly stretched in terms of underweight or short positioning.

“Let me be clear,” Orton added. “I still don’t love the set-up of small caps longer-term, and anyone thinking about playing for a move higher should recognize the importance of being active and having a tactical focus on high quality. Beyond that, there’s just too much junk in the index that I would avoid at all costs.”

High-quality software and marginal beta exposure

Growth has reversed nearly all of its outperformance relative to value since the start of the COVID-19 pandemic while negative sentiment remains high and institutional positioning very light. That said, Orton noted that the valuation spread between growth and value still has room to normalize. This burden will not be equally borne across all companies, and he said he believes that further valuation compression will be concentrated in the lower quality, non-earning, and low free cash flow companies. We’ve already seen many high-quality names thrown out with the bathwater, he said, adding that those companies are where he would focus, especially in large caps and select mid caps with defensive characteristics. In particular, he said, software is less cyclical, and recent earnings across the group highlight the industry’s relative insulation from economic worries. While labor has the biggest exposure to inflationary forces, Orton said those costs are more easily controlled by management than input or energy costs. Software can also help investors position for a tactical rally but also provide some safety given many of these companies have seen extreme valuation compression, stronger earnings momentum, and are not crowded in terms of positioning, he said.

What to watch

“We get some good reads on the consumer this week and also data on the job market,” Orton said. In addition to some important economic data releases this week, scheduled earnings reports include companies in information technology; software; semiconductors; video games; cybersecurity; and food processing; plus retailers that sell lingerie; shoes; clothing; fashion accessories; athletic apparel; camping gear; and pet supplies.

This week's data releases

Monday Inflation reports for Spain and Germany
Tuesday U.S. Consumer Confidence Index; Canada gross domestic product; Inflation reports for the Eurozone, France, and Italy inflation; China Purchasing Manager Index
Wednesday Institute for Supply Management U.S. manufacturing Purchasing Managers’ Index; Job Openings and Labor Turnover Survey; U.S. Federal Reserve Beige Book; Canada rate decision, IHS Markit manufacturing Purchasing Managers’ Index for Canada; China Caixin Services Purchasing Managers Index
Thusday U.S. initial jobless claims; ADP® National Employment Report
Friday U.S. employment and nonfarm payrolls; Services ISM® Report on Business®


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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.

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

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

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.

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

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

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

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.

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

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.

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 price/earnings ratio (P/E) measures a company’s current share price relative to its per-share earnings.

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

The Consumer Confidence Index (CCI) is a survey administered by The Conference Board that measures how optimistic or pessimistic consumers are regarding their expected financial situation.

The China Purchasing Manager Index, compiled by the National Bureau of Statistics of China, is based on a monthly survey of purchasing managers in 31 divisions of manufacturing enterprise and 43 divisions of non-manufacturing enterprise.

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 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.

Purchasing Managers’ Index data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies. PMI data features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as gross domestic product, inflation, exports, capacity utilization, employment, and inventories.

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

The ADP® National Employment ReportTM is a monthly measure of the change in total U.S. nonfarm private employment derived from actual, anonymous payroll data of client companies served by the payroll, tax service and human resources management company ADP. The report measures changes within a group of nearly 26 million U.S. workers and is produced by the ADP Research Institute® in collaboration with Moody’s Analytics.

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

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

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

The Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 97% of the total market capitalization of all U.S. incorporated equity securities.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 10% of the total market capitalization of the Russell 3000® Index.

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.

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CTA22-0345 Exp. 9/30/2022