Markets in Focus

Timely analysis of market moves and sectors of opportunity

May 28, 2024: Opportunities amid divergences

Key points

  • It’s not just mega-cap tech stocks fueling earnings growth anymore, which the market is indiscriminately rewarding.

  • With international equities outperforming since March, there are opportunities to increase exposure outside of the U.S. as part of building balance in portfolios.

  • Matt Orton, CFA, believes there are positive, fundamental market trends creating important opportunities in both equities and fixed income for investors with cash on the sidelines.

 


 

Not surprisingly, last week’s slew of U.S. Federal Reserve (Fed) speakers largely reiterated the view that the latest U.S. inflation figures were a step in the right direction, but much more improvement will be needed for policymakers to feel confident initiating rate cuts. Earnings have been strong and, at the same time, economic and inflation data are finally starting to show some initial signs of moderation.

“It wasn’t surprising to see rates push slightly higher last week given overzealous rate cut re-pricing after the last Consumer Price Index report, and market breadth was weak as a result,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“This isn’t a red flag, particularly given my belief that rate hikes are off the table and a December cut is the most likely outcome,” Orton said. “Earnings will be the ultimate arbiter of the bull market, and a spectacular report from a leading artificial intelligence chip designer has only strengthened first-quarter results.”

With 96% of companies reporting results, the earnings growth rate for the S&P 500 Index stands at 7.7%, which is well ahead of expectations.1 The net profit margin has increased to 11.8%, a big improvement from last quarter, last year, and the 5-year average.

“The market is finally reacting to fundamentals, where companies that report strong results and guidance are rewarded, and those that don’t are penalized,” Orton said. Moreover, we’re seeing a wide breadth of sectors return to earnings growth, with some laggards such as energy and healthcare approaching key inflection points. He added that’s why the top performers this year aren’t just dominated by the mega-caps but include sectors and industries such as financials, industrials, energy, and staples.

Some of the worst performers include a list of former high-flying tech and consumer discretionary names that failed to live up to expectations. Divergences that are occurring due to earnings are providing opportunities, and Orton said he expects to see even more divergences occur as the paths of global policy start to change.

“Selectivity matters, and this is a great time to build better balance in portfolios,” he said. “I believe in using downside opportunistically should we see some market consolidation as investors react to talk from central bank policy makers and continue to normalize rate cut expectations globally.”

Orton also said that complaints about the recent lack of market breadth have merit, but would argue they are overstated and distract from the positive fundamental trends underlying the market.

“The run in meme stocks has been fairly contained and doesn’t point to speculative excess like it did post-COVID,” he said. These moves need to be separated from the outperformance of the mega-cap tech stocks that generally dominated returns last year, he said. A growing number of companies have moved higher after reporting strong earnings, and Orton added that their recent performance highlights the durability of the secular growth drivers behind their earnings-per-share (EPS) growth.

Every sector in the S&P 500 except energy has been positive in May and, while information technology has dominated, this is largely the result of strong earnings and positive secular growth trends impacting the largest market-capitalization weightings.

The top five contributors to S&P 500 Index performance make up 57% of returns (a far cry from the 90%+ at the start of the year). As a result, only 30% of index constituents are outperforming month-to-date; however, nearly 70% are positive. Outside of the top five, there is much greater diversity to contributors to index performance.

From a macro perspective, Orton would argue that the backdrop remains supportive for further upside in equities. Economic growth is showing signs of moderating, but, according to the Federal Reserve Bank of Atlanta’s GDPNow™ model, it remains above-trend while the labor market remains healthy — even as it shows some initial signs of loosening, Orton said.

“Increasing calls for the demise of the American consumer have been offsides for the past two years and I would argue remain offsides today,” he said. “That’s important because American consumers delivered more than half of economic growth last year.”


S&P 500 first quarter earnings growth contribution by sector
(as of 5/24/2024)
S&P 500 first quarter earnings growth contribution by sector

Source: Bloomberg, as of 5/24/2024

He added that debt payments have yet to squeeze the average U.S. household. “In fact, required debt-service payments on mortgage and other consumer debt are still more manageable than they were ahead of the pandemic,” Orton said. Though interest payments are rising on non-housing debt, servicing costs for mortgage debt remain low and personal income continues to grow at a pace consistent with prior expansions. A lack of supply continues to prop up house prices, in turn making existing homeowners feel wealthier, and Orton expects these dynamics to support continued consumer spending in the second half of the year.

“However, this doesn’t mean that behaviors won’t change. We’ve seen some important changes reflected in first-quarter earnings,” he said. Consumers are focusing more on essentials as rising costs for services stretch the budgets of lower income earners. Orton also cautions not to ignore signs of consumer stress (such as rising delinquency rates) becoming increasingly evident mostly at the bottom-end of the consumer spectrum.

“This dichotomy opens up opportunities for investors to lean into these trends,” he said. “But it certainly doesn’t support avoiding risk assets.”

Themes to consider

Orton said now that earnings catalysts have largely passed, it will be important to see if further market gains will see a more balanced contribution from high-quality growth — and if the percentage of 52-week highs can expand again.

“In the very near term, it would help if rates resumed their downtrend– a break of the May 15 low around 4.35% would be a positive signal,” Orton said. “That said, I’ll also be closely watching whether we break above 4.50% on the upside, which would probably lead to increased concerns and some consolidation that could be used opportunistically.”

Orton believes that the main theme continuing to drive markets is artificial intelligence. “There should be no question about the long-term durability of this theme after the first-quarter earnings season,” he said, noting that throughout earnings the hyperscalers hiked their capital expenditure guidance for the year to support their artificial intelligence infrastructures, further highlighting that the AI theme is alive and well.

“While we’ve all been intently focused on a handful of companies here in the U.S., the rest of the world continues to march higher as well,” Orton said. International developed and emerging markets are both up nearly 5% in May. In fact, international developed markets are closing in on their all-time highs from 2021 as investors react positively to earnings that are coming in far better than feared, and a rate-cutting cycle in Europe that is likely ahead of the Fed.

Orton believes there are plenty of opportunities remaining for investors across the market. He is focused on the following themes:

  • Artificial intelligence 2.0. Orton has seen strength across the hardware names as the initial phase of the AI buildout continues as well as strong outperformance in sectors and industries outside of technology. “We’re seeing it in those levered to the growth of AI and building the infrastructure required to support the proliferation of software and process data by the large language models,” he said.

    Orton has seen investors who have looked at playing the “AI 2.0” phase be rewarded over the past month or so. “We’ve seen incredible strength from the utilities as the need to invest in the grid is all too evident,” he said, and believes that electric utilities, and independent power and renewable companies still have a runway for further growth, especially as they become the momentum names. Uranium names have rocketed higher on speculation that we’ll see increased investment in nuclear power, though Orton remains skeptical, especially after his recent meetings with U.S. policy makers.

    Electrical equipment companies are still the source of strength in industrials as better electric and thermal storage will be required to enable the transition to cleaner power. Orton cautions not to forget about the miners — where better balance sheet prudence coupled with strong demand for base metals like copper should keep a floor on hard commodity prices.

    “Trillions of dollars will be spent on infrastructure buildout to support the growth of artificial intelligence, and I think there’s a long runway of opportunity to invest in the companies that are beneficiaries of the capital expenditure spending,” Orton said.

  • Positioning for divergences. In the United States, Orton sees a growing divergence between macroeconomic data and earnings growth. “It’s nothing pernicious, but we’re in a unique period where the macro is slowing (i.e., normalizing), yet earnings are actually broadening and accelerating,” he said.

    The divergence is driven by improving manufacturing versus slowing services and historically moderating gross domestic product (GDP) and growing earnings, which, Orton said, has been a very strong backdrop for investing in stocks. “We’re also seeing divergences across global central banks,” he said.

    Many emerging market central banks are already well into their easing cycles, and ahead of the inflationary surge in 2021 while the European Central Bank (ECB) and Bank of England (BOE) look set to start easing in the near future. The Fed is still in a holding pattern while the Bank of Japan is in a rate-hiking cycle.

    “These divergences create opportunities for investors, but selectivity and quality are incredibly important given elevated fragility across these economies,” Orton said. “Earnings season in Europe has been better than feared with unexpected margin growth, and I favor leaning into financials, luxury, and select tech and industrials. I also believe the best way to play the end of the deflationary cycle in Japan is via banks, whose strong performance can continue.”

    He added that emerging markets remain attractive with the sustainability of China’s rally being the big question mark. “Given the fast money that has moved into the country and some of the recent property support policies, I think the upward momentum can continue,” Orton said. He believes markets outside of China, such as India, remain the most attractive long-term investment opportunities across the emerging market complex and prefers the region.

  • A summer for small caps? Orton believes that the underperformance of small-cap companies over the past few years makes sense when looking at earnings results. The S&P 600 Index’s annual profits are currently less than the first-quarter earnings of the largest company in the S&P 500, and S&P 600 aggregate earnings before interest and taxes (EBIT) margins have almost halved from their peak of 9.0% in the third quarter of 2022, dropping to 4.9% at the end of last quarter. He said the gap between the profitability of S&P 600 small caps and their large- or mid-cap counterparts is striking.

    However, Orton is starting to see a recovery in earnings for smaller companies with first-quarter results coming in ahead of expectations and merger and acquisition activity accelerating. “If earnings momentum can stay on track and finally show that it’s inflecting higher, small caps have the potential to rally strongly off their base, fueled by the valuation discount,” he said. Orton added that he likes the current technical set-up, and believes that if we can break the March high on the Russell 2000® Index, it will help lead to inflows.

What to watch

This week, inflation data will take center stage with consumer price readings from the Euro-area, Australia, and Japan, plus the U.S. Federal Reserve’s preferred measure of inflation in the core Personal Consumption Expenditures (PCE) Price Index. With interest rate cut uncertainties stalling last week’s rally, the core PCE deflator has the potential to move markets.

Orton expects core PCE to slow modestly in April, but more improvement will be required for policy makers to ultimately initiate rate cuts. He also thinks it will be worth paying attention to Federal Reserve Bank of New York President John Williams, who will be speaking at the Economic Club of New York around noon Thursday.

“His recent remarks suggest he thinks that policy is ‘restrictive’ and ‘in good place,’ which supports the central line of thinking on the Federal Open Market Committee (FOMC), as well as my forecast for the Fed cutting cycle to commence in December,” Orton said.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of May 24, 2024.

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
A blended net profit margin combines actual net profit margins from companies that have reported earnings and estimated margins for companies that have yet to report. A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.

Companies that are levered to the growth of artificial intelligence have earnings that directionally follow AI expansion. Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.

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.

Earnings before interest and taxes (EBIT), also known as operating earnings, operating profit, or profit before interest and taxes, can be calculated as revenue minus expenses excluding taxes and interest.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.

Federal Reserve GDPNow™ is model estimate for real gross domestic product (GDP) growth (seasonally adjusted annual rate). It is produced by the Federal Reserve Bank of Atlanta, but it is not an official forecast of the Atlanta Fed. Rather, it is best viewed as a running estimate of real GDP growth based on available economic data for the current measured quarter. There are no subjective adjustments made to GDPNow. The estimate is based solely on the mathematical results of the model.

Gross Domestic Product (GDP) is the total value of goods and services provided in a country during one year.

Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.

Companies that are levered to secular growth mega-trends have consistent or increasing earnings over the long term, 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.

Growth sectors are the segments of the equity market, like technology, in which companies are expected to increase their earnings at rates higher than the average growth rates for other industries and for the market overall.

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.

Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.

Large language models (LLMs) are artificial intelligence algorithms that can recognize, summarize, translate, predict, and generate text, as well as respond to questions in a conversational manner, by massively large sets of data. Large language models learn context and meaning by tracking relationships in sequential data, such as words in a sentence.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

A meme stock refers to the shares of a company that has attained viral popularity due to heightened social sentiment, typically after being featured or heavily discussed on social media or other online platforms.

The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, is known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.

Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.

Risk assets refer to investments such as equities, commodities, high-yield bonds, real estate, and currencies, where the value may rise or fall due to fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.

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.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.

The S&P 600 Index is an index of small-cap stocks managed by Standard and Poor’s. It tracks a broad range of small-sized companies that meet specific liquidity and stability requirements.

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

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

 

M-553371 Exp. 9/28/2024


May 20, 2024: Macro noise, micro opportunities

Key points

  • Market breadth appears to be improving, the market is rewarding idiosyncratic risk, and earnings results are guiding stock prices.

  • April core Consumer Price Index (CPI) data was in line with expectations — for the first time in four months — and the details support the possibility of softer inflation readings in the future.

  • Matt Orton, CFA, believes there are clearly plenty of opportunities remaining for investors in this market, but it increasingly matters what they own going forward.

 


 

For some reason, investors just can’t get comfortable with the market as it continues to make new all-time highs. The fundamentals that matter — earnings, margins, and yields — are providing a supportive backdrop where both bonds and equities can push higher.1 However, there is plenty of noise distracting investors, including the massive meme stock rally, hawkish remarks from U.S. Federal Reserve (Fed) officials, and a string of weaker than expected economic data.

“This noise has led to a very high level of skepticism of the market right now based on my meetings with clients over the past few weeks,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. Meanwhile, the American Association of Individual Investors Sentiment Survey allocation to stocks is still below its 2021 levels, and the ratio of bulls to bears remains well below the levels from last year.

“I think part of the issue for investors is that this hasn’t felt like a broad-based, risk-on rally,” Orton said. “We’ve seen recent outperformance from defensive sectors like utilities and staples while technology also continued to perform well.” This has led to the broader market of stocks, represented by the S&P 500® Equal Weight Index, continuing to underperform the market reflected by the S&P 500 Index.

“If you look a bit more carefully, I would argue that breadth is finally improving,” Orton said. Earnings results are guiding the stocks that are being rewarded or penalized, and he finds it encouraging that the market is rewarding idiosyncratic risk. “Given how strong earnings season has been, it makes sense that nearly 80% of the S&P 500 Index stocks are trading above their 200-day moving averages.”

Orton also said that small-cap stocks have outperformed the S&P 500 Index this month, and their 2024 year-to-date performance has moved back into positive territory. “While I don’t advocate for chasing the market, I do still feel comfortable deploying capital on weakness, focusing on higher quality, more cyclical parts of the market where we’re seeing a re-acceleration in earnings growth,” he said. Orton believes that the continuing change in stocks leading the market indicates that there are still plenty of opportunities for diversification, particularly overseas and in sectors and industries that are levered to secular growth mega-trends.

“We finally received some good news on the inflation front last week, reaffirming my conviction that the Fed’s next move will be a cut, given its easing bias,” Orton said. The April core Consumer Price Index (CPI) data was in line with expectations for the first time in four months, and the details support the possibility for softer inflation readings than the first quarter. “This should be welcome news for a data-dependent Fed, though one month does not make a trend,” he said. “We’ll need several more months of progress before the Fed will be comfortable enough for its first rate cut.”

Orton said that the latest housing data was encouraging, and improving housing stock could help the ongoing downshift in shelter inflation.

“We’re not out of the woods yet on April core Personal Consumption Expenditures (PCE), which will be influenced by the stronger than expected Producer Price Index (PPI) data,” Orton said. “I think the recurring predictions of the American consumer’s demise, following weak retail sales, are overdone and should not be extrapolated as a reason for inflation continuing to come down.”

Based on the current data, Orton’s base case is for the Fed to hold rates steady through summer and the election, most likely initiating its first cut in December.


Core Consumer Price Index moderates to 3.6%
Core Consumer Price Index
Core Consumer Price Index

Source: Bloomberg, as of 5/20/2024

Orton said that even if the first Fed cut doesn’t come until December, the environment remains supportive for risk assets. Yields look to be breaking the uptrend that has been in place all year, and the U.S. dollar has been following lower. At the same time, earnings have been surprising to the upside globally while positioning in equities is still not stretched.

“The S&P 500 Index’s first-quarter 2024 earnings per share growth stands at 5.25%, well ahead of expectations, with 81% of companies reporting results that exceeded expectations,” Orton said. He also noted that the number of companies citing inflation on earnings calls has declined to the lowest level since the second quarter of 2021, which could be feeding into a continuation of strong margin results.

“The blended net profit margin for the S&P 500 Index sits at 11.7%, well ahead of last quarter, last year, and the 5-year average,” Orton said. “This is another reason to be encouraged by the fundamentals underlying the current market environment.” He is also encouraged by the strength seen in more defensive sectors, like utilities, while information technology continues to perform well. “Utilities is now the best performing sector month to date, and the second-best performing sector year to date following communications,” he said.

“If we’re going to talk about increasing market diversity beneath the surface, then we need to talk about international markets,” Orton said. “International developed and emerging markets are performing quite well and remain incredibly underweight in investor portfolios following years of underperformance relative to the United States.” He added that earnings season in Europe has surpassed expectations, with approximately 75% of companies meeting or exceeding bottom line estimates. “While higher margins are driving earnings revisions, companies across sectors keep on lifting their guidance for the second half of 2024, increasing investment appetite in Europe.”

Even the United Kingdom has seen improvement in underlying economic trends, which Orton said has been reflected in strong gains across the Financial Times Stock Exchange (FTSE) 100 Index. He believes that the European Central Bank and Bank of England are also likely to start easing rates sooner than the Fed, providing additional tailwinds for these markets.

Across the emerging market complex, Orton said that a massive rally in China has sustained itself and pushed broader emerging market indices to escape velocity. “Despite the greater than 10% move quarter to date across the emerging market complex, it still sits nearly 25% below the highs of 2021,” he said. Renewed strength in regions like India, Eastern Europe, and Latin America could continue the rally.

Themes to consider

Orton said investors should consider how they can increase exposure to improving market breadth and the rotation that will likely support the bull market. This week, positive earnings and guidance from one of the biggest names in artificial intelligence, which was responsible for 11% of last year’s S&P 500 Index returns, could signal that there’s still room to run for the semiconductor trade that has dominated technology.

“The strength in sectors like utilities sends a clear signal that investors are already looking for ways to diversify their exposure to the artificial intelligence (AI) trade,” Orton said. “Power is potentially a bottleneck for the AI theme, and we’ve seen electric utilities and renewable electricity producers rally as investors realize that significant investment is already being made to ensure that we have enough power for our future needs.” Of all 11 sectors, the utilities sector’s 33.4% year-over-year earnings growth rate was the second highest.

Orton believes that there are clearly plenty of opportunities remaining for investors in this market, it just increasingly matters what they own going forward. He is focused on the following themes:

  • Artificial intelligence 2.0. Orton said that data centers already consume more power than the entire United Kingdom, and the rapid buildout that is needed will soon break the electric grid unless massive investments are made. “I had the privilege of meeting with members of Congress recently to discuss these issues, and I left convinced that capital expenditures will benefit electric utilities and the industrial and materials companies needed for construction,” he said. Orton expects that trillions of dollars will be spent, and traditional fossil fuels will be required. Better electric and thermal storage will also be required to transition to cleaner power. “Don’t forget about the miners either, where better balance sheet prudence coupled with strong demand for base metals, like copper, should keep a floor on hard commodity prices,” he said. Orton believes that a rebound in Chinese growth could also be supportive for mining companies.

    “Overall, AI’s dominance and its enduring ability to drive growth continue to be highlighted on earnings calls, and the massive levels of capital expenditure — projected to be $200 billion-plus just over the next year from the four major hyperscalers — will benefit a broad range of sectors.” Orton recommends finding well-positioned companies in industries that will benefit from capital expenditures. “I believe there are still many good opportunities to get into high-quality companies that have accelerating earnings growth.”

  • Being selective in international stocks. Orton said that it’s tough to ignore either the rally in China or the strength in Europe. Unexpected margin growth has meant that earnings season in Europe was better than feared. Companies across sectors have reinforced their positive outlooks for the second half of 2024, leading to an increased appetite for investment in Europe. “I still believe European financials provide a great way to get leverage to improving economic fundamentals in a sector with strong upward momentum,” Orton said.

    Also in international developed markets, Orton said he continues to advocate for using April’s downside in Japan to increase exposure. He believes that Japanese banks in particular remain attractive as the best way to play the end of the country’s deflation story. “Interest rate normalization will benefit the Japanese banks, and growing hopes of a commercial bank-funded capital expenditure cycle provides an opportunity for upside,” he said.

    Orton also said that emerging markets remain attractive, although the sustainability of the rally in China is the biggest unknown. “Given all of the fast money that has moved into the country and some of the recent property support policies, I think the upward momentum can continue,” he said. However, he prefers India and believes that markets outside of China remain the most attractive opportunities for long-term investment.

  • A summer for small caps? Orton believes that the underperformance of small-cap companies over the past few years makes sense when looking at earnings results. The S&P 600 Index’s annual profits are currently less than the first-quarter earnings of one of the biggest stocks in the S&P 500, and S&P 600 aggregate earnings before interest and taxes (EBIT) margins have almost halved from their peak of 9.0% in the third quarter of 2022, dropping to 4.9% at the end of last quarter, he said. The gap between the profitability of S&P 600 small caps and their large- or mid-cap counterparts is striking.

    However, Orton is starting to see a recovery in earnings for smaller companies with first-quarter results coming in ahead of expectations and mergers and acquisition activity accelerating. “If earnings momentum can stay on track and finally show that it’s inflecting higher, small caps have the potential to rally strongly off their base, fueled by the valuation discount,” he said.

What to watch

Investors may turn their focus to next week’s Purchasing Managers’ Index (PMI) data and this week’s earnings report from one of the biggest names in artificial intelligence to recalibrate their views on the semiconductor stage of the AI cycle. Other earnings reports might offer more reads on the state of the American consumer.

The U.S. economic calendar is pretty light, with the highlight being Wednesday’s release of the minutes from the Fed’s April/May monetary policy meeting. Other data releases include European business surveys and U.K. inflation data for April. Fed Governor Christopher J. Waller will make public remarks on Tuesday and Friday.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of May 17, 2024.

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
The American Association of Individual Investors Sentiment Survey asks individual investors where they think market is heading in the next six months, dividing the responses into “Bullish,” “Neutral,” and “Bearish” categories.

A blended net profit margin combines actual net profit margins from companies that have reported earnings and estimated margins for companies that have yet to report. A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.

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 “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy,” also known as core CPI, is an aggregate of prices paid by urban consumers for a typical basket of goods, excluding food and energy. Core CPI is widely used by economists because food and energy have very volatile prices.

Cyclical forces describe trends and changes in market conditions that occur as the economy passes through the business cycle’s stages of expansion, peak, recession, and recovery.

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. defensive sectors

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

Earnings before interest and taxes (EBIT), also known as operating earnings, operating profit, or profit before interest and taxes, can be calculated as revenue minus expenses excluding taxes and interest.

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.

Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.

Companies that are levered to secular growth mega-trends have consistent or increasing earnings over the long term, 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.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.

A meme stock refers to the shares of a company that has attained viral popularity due to heightened social sentiment, typically after being featured or heavily discussed on social media or other online platforms.

Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.

The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, is known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.

Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.

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.

Risk assets refer to investments such as equities, commodities, high-yield bonds, real estate, and currencies, where the value may rise or fall due to fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.

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

Quality investing is a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance, as reflected in financial metrics such as ratios of return to equity and debt to equity, as well as to earnings variability.

The term renewable energy generally refers to electrical energy generated by wind, solar, and hydroelectric sources.

A risk-on investment is typically fueled by a strong growth environment and is more apt to rise when good news fuels bullish sentiment and investor expectations of favorable risk/reward ratios.

Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.

Secular 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.

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance. The opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.

Indices
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 S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.

The S&P 600 Index is an index of small-cap stocks managed by Standard and Poor’s. It tracks a broad range of small-sized companies that meet specific liquidity and stability requirements.

 

M-550349 Exp. 9/20/2024


May 13, 2024: CPI in focus

Key points

  • A Consumer Price Index report that is in line with or better than expectations could support a continued drift higher in stocks. Trends in housing costs could be key.

  • Keep in mind the rotation that is taking place beneath the surface as well as the underlying strength of earnings.

  • Interesting areas include artificial intelligence and its spinoff activity, select countries and sectors in global equities, and possibly small caps.

 


 

All eyes this week will be on Wednesday’s Consumer Price Index (CPI) — and for good reason.

“The U.S. Federal Reserve’s dovish stance in the face of sticky inflation has provided support to both bonds and equities, but to keep the party going the data eventually needs to cooperate,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

CPI has consistently surprised to the upside this year, so Orton said he suspects that an in-line report or better will be good enough for the S&P 500 Index to continue to drift higher. The recent stalling of the upward momentum of interest rates, the dollar, and commodities also has provided a tailwind to the market, and he said any positive news on inflation should allow this trend to continue. The strength of earnings is also notable with first-quarter earnings per share (EPS) growth coming in nicely ahead of expectations.1 With most of the S&P 500 Index having reported results, more than 80% of companies have reported a positive EPS surprise with a blended net profit margin of 11.7% (higher on a quarter-over-quarter and year-over-year basis). Critically, the breadth of earnings is expanding with a better balance of sectors contributing to earnings growth over the past year. This positive corporate fundamental backdrop coupled with strong but moderating economic growth has allowed equities to retrace most of the April selloff.

“That said, I’m encouraged that positioning does not look anywhere near as stretched as it was at the recent highs,” Orton said. “This is an environment where I continue to feel comfortable deploying capital on market weakness and focusing on higher quality, more cyclical parts of the market where we’re seeing a re-acceleration in earnings growth. I believe there are still plenty of opportunities for diversification, particularly in sectors and industries that are levered to secular growth mega-trends as well as overseas.”

The biggest risk to making new all-time highs in the very short term is Wednesday’s CPI report and the potential that the anticipated downturn in shelter inflation comes after April, Orton said.

Currently, almost every forecaster on the street is looking for a 0.3% month-over-month core CPI print. If there are gains in rent of primary residences and owners’ equivalent of rent of primary residences (OER) in April similar to what we had in March, this would put CPI on the cusp of a rounded 0.4% month-over-month core gain.

In such a scenario, Orton said there is a risk of another breakout in longer-dated yields, which could cause a pullback in equities, particularly in some of the higher-duration sectors that have rallied over the past few weeks. He said to watch out for utilities, which after a torrid rally now have a dividend yield lower than the yield on the U.S. Treasury 10-year note.

But from a fundamental perspective, Orton said he would rather have slightly elevated inflation with stronger growth than to sacrifice the latter. Earnings have been improving in this environment and for many companies, this inflationary environment has actually provided a consistent boost to earnings before interest and taxes (EBIT) while margins have improved.

“So if we do get a hotter than expected CPI print, I would consider using downside to accumulate the highest quality underperformers,” he said. “I don’t expect rates to remain elevated for too long as the strong data we received in the first quarter has raised the bar for further upside surprises in U.S. economic data. I suspect demand for duration will increase with yields getting more attractive and some of the key risk events having passed.”


Economic data is coming in soft, but not cause for concern ... yet
Citi Economic Surprise Index since the beginning of 2023
Citi Economic Surprise Index since the beginning of 2023

Source: Bloomberg, as of 5/3/2024

The story beneath the surface

While he said there’s still too much focus on and noise around the ultimate path of the Fed, Orton believes the real story should be the rotation that is taking place beneath the surface as well as the underlying strength of earnings.

Utilities have been a big underperformer over the past year but are making a huge comeback this quarter, Orton noted, driven by the realization that the electric grid is woefully unready for the surge in demand for the energy needed to power the artificial intelligence (AI) revolution. This realization already is playing out with bold proposals in Georgia and Tennessee. In fact, utilities are now the second best-performing sector year to date in the S&P 500 Index.

There also has been continued strength in financials, driven by banks, consumer finance, and capital markets companies rather than just insurance. Materials and industrials also remain strong in addition to technology. While the recent pullback in interest rates has helped, Orton said this rotation has really been driven by earnings strength and corporate outlooks going forward. At this late stage of the first-quarter earnings season, S&P 500 companies continue to perform well compared with expectations. Both the percentage of S&P 500 companies reporting positive earnings surprises and the magnitude of earnings surprises are above their long-term averages, while strong capital spending is another positive sign for activity going forward with first-quarter capital expenditures on track to rise 8% year over year.

“I continue to believe AI investment and reshoring should provide a tailwind to earnings growth and help the S&P 500 continue to broaden beyond the Magnificent Seven,” he said.

Three areas to consider

Orton said he continues to urge investors to consider building balance in portfolios by leaning into the rotation that has been taking place across markets. The April selloff helped digest the froth, but without an erosion of the market breadth: An above-average 67% of global stocks trade above their 200-day moving averages. International markets are either pushing all-time highs or have built a base upon which they are rallying. Cyclicality has been outperforming while technology and the mega caps have generally held up after posting good earnings. The Fed still maintains an easing bias and interest rate hikes remain essentially off the table, even if inflation remains stubborn in the short term.

“There are still many areas of opportunity across the market, but I believe selectivity is increasingly important as dispersion is high and idiosyncratic drivers of growth are in focus,” Orton said. Accordingly, his investment playbook includes a strong focus on three areas:

  • Artificial intelligence 2.0. Cyclicals again broadly outperformed last week and Orton continues to advocate for thinking about leaning into sectors like financials and industrials, particularly in industries like electrical equipment that have exposure to key secular growth tailwinds. The dominance and durability of artificial intelligence to drive growth continues to be highlighted on earnings calls and he expects massive levels of capital expenditures — with a projected $200 billion-plus coming just in the next year from the four major hyperscalers — to benefit a broad range of sectors. Rather than just focusing on the obvious beneficiaries so far like chipmakers, servers, and networking equipment, Orton suggested considering related opportunities in areas such as the electrical equipment companies, materials, and industrials firms involved in this buildout. We’re also seeing innovation from aerospace and defense companies integrating AI into product offerings. He further expects select materials companies to benefit from better balance sheet prudence at mining companies coupled with strong demand for base metals like copper for both AI and broader electrification projects. “I believe there are still many good opportunities to get into high-quality companies that have accelerating earnings growth,” he said.

  • Being selective in international stocks. International equities are making a comeback relative to those in the United States, and there has been strong performance across a broad range of sectors as global earnings exceed expectations. More sectors are seeing a growing percentage of issues make new highs versus lows, a positive signal in the durability of the rally. Fund flows last week also favored European and Asian equities over U.S. stocks, with Asia developed markets being the top-performing region for the second consecutive week. Europe saw its second week of inflows in a row for the first time since February.

    All of this signals rising momentum on the back of improving economic growth and better than feared earnings, Orton said. The divergence between the Fed and other central banks remains in focus and has set up an environment that he believes should support growth internationally. Emerging markets are quite attractive given a dollar that looks to be topping coupled with elevated commodity prices and lower interest rates. Latin America — Mexico and Brazil in particular — looks increasingly attractive given its exposure to metals and oil, while Asia apart from China benefits from the semiconductor trade as well as from a recovering Chinese economy. That said, India remains one of Orton’s preferred regions, and he expects to see the rally there resume after Indian elections in early June. European banks have been a standout trade in the last couple of months, and Orton said he continues to like the group as economic growth comes in stronger than expected. Based on recent earnings results, he said he believes this momentum can continue, noting that the EURO STOXX® Bank Index is up 27% year to date. He said Japanese banks are also attractive and stand to benefit from additional rate hikes in Japan. To Orton, the recent pullback in Japan looks buyable.

  • A summer for small caps? Earnings momentum has favored large caps, especially in the United States. The mega caps have been comfortably beating earnings expectations, and thus larger companies in the U.S. are generating 1-year EPS growth rates around 15% higher than smaller ones. In addition, larger companies tend to be higher quality with higher returns on equity. So why should small caps start to perform? Orton noted that their persistent underperformance has led to size having one of its most extreme valuation differentials since the peak of the technology, media, and telecom bubble in 2000. If earnings momentum changes, he said small caps have the potential to rally strongly, fueled by that valuation discount. Earnings growth for small caps in the U.S. looks set to re-accelerate in the second half of the year as some large-cap companies face tough comparisons to their performance last year. That, Orton said, could finally start to narrow the EPS growth differential. In Europe, smaller companies are more levered to activity and an industrial cycle that looks set to finally pick up. If measurements such as expectations for Eurozone manufacturing rise, Orton said it could indicate an accelerating economy and an environment in which smaller companies could be more likely to outperform larger ones.

What to watch

Along with the Consumer Price Index, Wednesday brings a report on retail sales. Orton said both readings have the potential to move the needle significantly with respect to expectations for Federal Reserve interest rate cuts, especially in light of the repricing that took place last week after the jobs report.

While earnings season is all but done, two big-box retailers will report results this week that should provide some important reads on the state of the American consumer generally and lower-income consumers in particular. Four noteworthy Chinese companies also report earnings this week.

In a busy week of public comments from Fed officials, Orton said he would pay close attention to what is said after Wednesday’s CPI and retail sales reports:

  • Monday — Federal Reserve Bank of Cleveland President Loretta Mester.

  • Tuesday — Fed Chair Jerome Powell and Fed Governor Lisa Cook.

  • Wednesday — Federal Reserve Bank of Minneapolis President Neel Kashkari and Fed Governor Lisa Bowman.

  • Thursday — Fed Board of Governors Vice Chair for Supervision Michael Barr, Federal Reserve Bank of Philadelphia President Patrick Harker, Federal Reserve Bank of Atlanta President Raphael Bostic, and Mester.

  • Friday — Fed Governor Christopher Waller and Federal Reserve Bank of San Francisco President Mary Daly.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of May 10, 2024.

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
A blended net profit margin combines actual net profit margins from companies that have reported earnings and estimated margins for companies that have yet to report. A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.

Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

The Citi Economic Surprise Index tracks the relationship between economic data and economists’ expectations for a range of economies. A positive reading means that data releases have been stronger than expected, and a negative reading means that data releases have been worse than expected.

Comps, short for comparables, carries different meanings depending on the industry and context, but generally entails a comparison of financial metrics — often for two different time periods — or other factors to quantify performance or determine valuation.

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 “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy,” also known as core CPI, is an aggregate of prices paid by urban consumers for a typical basket of goods, excluding food and energy. Core CPI is widely used by economists because food and energy have very volatile prices.

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.

Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.

Dividend yield, which is expressed as a percentage, is a ratio of the current rate of dividend payout divided by the current stock price.

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

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.

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

Earnings before interest and taxes (EBIT), also known as operating earnings, operating profit, or profit before interest and taxes, can be calculated as revenue minus expenses excluding taxes and interest.

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.

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. Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.

The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index primarily during 2023, when their returns overshadowed the broader market. As of Dec. 29, 2023, they were Alphabet, Amazon, Apple, Meta Platforms, Microsoft , NVIDIA, and Tesla. As of April 30, 2024, Tesla had dropped out of the top seven by market capitalization, though the others remained.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.

The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.

The owners’ equivalent of rent of primary residences (OER) is a component of the Consumer Price Index that helps measure changes in the cost of shelter in the United States. It is based on the answers from consumers who own their homes to the question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.

The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.

Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.

Reshoring describes the effort to bring manufacturing and other services back to the United States from overseas operations.

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

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.

Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.

Secular 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.

Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing or more variable data.

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance. The opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.

Indices
The EURO STOXX® Banks Index tracks stocks in European super sector of companies that derive their primary source of revenue from banking.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

 

M-545685 Exp. 9/13/2024


May 6, 2024: Not a year to ‘sell in May and go away’

Key points

  • After April’s rapid shifts in market sentiment, May should give investors a chance to consider strong corporate earnings and a solid economic backdrop.

  • Commentary this week from a full roster of Fed officials could have an important impact on the course of interest rate expectations.

  • This is a time to think broadly about the impact of artificial intelligence and to consider the generally improving picture for global stocks, but to tread carefully around retail stocks where selectivity is doubly important.

 


 

April felt like a marathon as a confused market narrative toggled between optimism and pessimism in response to virtually every economic data point and earnings release.

May should be different, but no less interesting or important, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“Thankfully,” he said, “the barrage of economic data, most first-quarter earnings, and the May Fed meeting are behind us. This should give investors a chance to recover and properly consider what I would argue are strong corporate results amid a solid economic backdrop.”

U.S. Federal Reserve (Fed) Chair Jerome Powell’s dovish press conference confirmed the Fed’s easing bias and essentially took the prospect of interest rate hikes off the table. Coupled with a weaker than expected payrolls report that confirmed a labor market slowly coming back into balance, longer-term U.S. Treasury yields and the U.S. dollar fell sharply while risk assets rallied. Orton said he remains optimistic on risk assets and suspects that equities can grind higher in the more catalyst-light few weeks until the next Federal Open Market Committee (FOMC) meeting in June.

“This is an environment where I feel more comfortable deploying capital on market weakness, particularly into high quality, more cyclical parts of the market where we’re seeing a re-acceleration in earnings growth due to strong secular growth mega-trends,” Orton said. “This is not the time to ‘sell in May and go away.’ Rather, April showers seem to have brought some May flowers.”

The relief provided to equities from falling longer-dated yields was welcome, but Orton said there’s still more work to do before we can have confidence that the recent uptrend in yields has reversed. Perhaps this week’s public comments from Fed officials will provide the catalyst. If 10-year yields can stay under 4.5% and push back toward 4.4% where the recent acceleration higher really took off, then Orton believes this could set up a rally to new all-time highs for the S&P 500 Index. The front end of the yield curve saw some big moves after the FOMC meeting, but the Fed’s lack of urgency to get started with interest rate cuts, coupled with a high hurdle to any meaningful reinjection of right-tail risk, means volatility likely falls. Overall, Orton said it’s encouraging to see some of the drivers of increased macroeconomic volatility fall after last week’s data, providing tailwinds for risk assets to push higher.


The labor market is coming into better balance
Month over month (m/m) change in nonfarm payrolls
Month over month (m/m) change in nonfarm payrolls

Source: Bloomberg, as of 5/3/2024

Ultimately, Orton said investors should consider focusing on corporate fundamentals, which continue to be a source of optimism for investors. All of the macroeconomic data points are important for setting the operating environment, but Orton has said for a while that earnings will be the ultimate arbiter of the bull market. And earnings have been strong. More than 80% of the S&P 500 Index has reported results, and earnings growth has come in nicely ahead of expectations across sectors and industries.1 Of companies that have reported so far, 81% beat earnings per share (EPS) expectations. Moreover, as Orton anticipated at the start of the year, analysts are raising their 2024 EPS expectations for sectors like energy, materials, industrials, and financials as global growth continues to surprise to the upside. Positive results and guidance have been rewarded while misses have been penalized, setting a strong backdrop for stock selection. Based on the results from the consumer staples companies that have reported so far, Orton said he expects dispersion to remain elevated across the retailers that will report earnings in coming weeks, and he expects management conference calls to provide useful data on changes in consumption habits.

Three areas to consider now

Powell confirmed the Fed’s easing bias and essentially took rate hikes off the table. Orton said this, coupled with payrolls data that confirmed a labor market that is slowly coming back into balance, makes it harder to see another rate acceleration like the one in early April that was problematic for risk assets. EPS growth is broadening, investor sentiment has returned to neutral, and breadth is robust with 70% of global stocks, as represented by the MSCI All Country World (ACWI) ex-USA Index above their 200-day moving average, as of May 3, 2024. Orton said he would push back against some of the bearish narratives that point to structural shifts in inflation, heightened risks due to investor concentration, and a lack of historical precedence of holding rates steady at the end of a hiking cycle for so long.

“We knew the last mile of disinflation was going to be the most difficult, and recent macro data provides hope that more progress can be made,” he said. “Let’s also not forget that sticky inflation tends to correspond to stronger-for-longer pricing power for corporations, and better corporate profitability tends to lead to higher capital expenditure. Just four mega-cap companies have plans to invest nearly $200 billion in the next year alone.”

The mega caps also have largely delivered on extremely elevated expectations, providing tailwinds for the broader market. While Orton remains optimistic, he believes selectivity remains critical, and he continues to favor considering moves that would add cyclical exposure to complement technology and to build better balance in portfolios.

Against this backdrop, Orton said his investment playbook would include giving close consideration to several key areas:

  • Artificial intelligence 2.0. Orton has advocated thinking about leaning into cyclicality, and after this earnings season he said he remains confident in that call, especially for companies with exposure to key secular growth tailwinds. And right now he said that means artificial intelligence (AI). In fact, he said one of the main takeaways from earnings is the dominance that AI will play over the next few years in driving growth. The cloud titans are spending massive sums to build out AI data centers. These vast capital expenditures play directly to the thriving makers of chips, servers and networking equipment. But Orton said he believes it’s also smart to focus on plays in the electrical equipment companies, materials, and industrial firms involved in this buildout.

    “This is AI 2.0, and we’re already seeing incredibly strong growth in companies associated with the increased capital expenditure that we’ll see over the next year plus,” he said. In the materials space, he sees copper prices near $10,000 a ton highlighting the immense need for the metal across the AI buildout as well as the push for electrification while industrials broadly provide what he sees as a quality play on increased capital spending. “I believe there are still many good opportunities to consider getting into high-quality companies with accelerating earnings growth,” he said.

  • Be careful around retail. Consumption might be on solid footing in the aggregate data, but Orton noted that companies are starting to see spending habits shift as inflation pressures linger. One of the largest fast-food chains saw continued weakness, and a leading chain of coffee houses had “terrible results,” Orton said, partially due to “occasional customers” seeking more value and visiting less frequently. Meanwhile, other staples companies reported softness in discretionary spending. It’s clear that higher food and shelter inflation has weighed on discretionary spending across general merchandise categories, he said, which is why he has a generally unfavorable outlook on consumer staples outside of a few key players that are more exposed to the value trade. Once again, he said, selectivity will be very important going forward, especially in the consumer discretionary space as 50% of the companies in that sector have yet to report earnings.

  • International selectivity. International equities as represented by the MCSI ACWI (All Country World Index) ex USA Index are making a comeback relative to U.S. stocks as represented by the S&P 500 Index, and there has been strong performance across a broad range of sectors as earnings surprise to the upside globally. China has posted some decent economic data for the first time in a while, helping emerging markets to outperform, while European banks have been a standout trade over the past two months as growth surprises to the upside. Based on recent results, Orton said he believes that this momentum can continue (the EURO STOXX® Banks Index is up 22.8% year to date) and that any additional rate hikes in Japan will benefit Japanese banks that also have performed well. The recent pullback in Japan still looks buyable to Orton even after the move higher last week. Across the MSCI EAFE® (Net) Index, a number of sectors are seeing an increasing percentage of stocks make new highs versus lows — a positive signal in the durability of the rally — with strength in financials, materials, utilities, industrials, and healthcare. The divergence between the Fed and other central banks remains in focus and has set up an environment that Orton says should support growth internationally. Energy companies in Europe also have an opportunity to surprise to the upside as they report earnings, and Orton said he would consider adding exposure if EPS growth inflects.

What to watch

With holidays in Japan and the U.K., plus a lighter data calendar, the focus shifts to a full roster of Fed speakers:

  • Monday: Federal Reserve Bank of Richmond President Tom Barkin and Federal Reserve Bank of New York President John Williams.

  • Tuesday: Federal Reserve Bank of Minneapolis President Neel Kashkari.

  • Wednesday: Fed Board of Governors Vice Chair Philip Jefferson, Federal Reserve Bank of Boston President Susan Collins, and Fed Governor Lisa Cook.

  • Thursday: Federal Reserve Bank of San Francisco Mary Daly.

  • Friday: Fed Governor Michelle Bowman, Federal Reserve Bank of Dallas President Lorie Logan, Federal Reserve Bank of Chicago President Austan Goolsbee, and Fed Board of Governors Vice Chair for Supervision Michael Barr.

On the data front, Friday’s University of Michigan Index of Consumer Sentiment will be the highlight. On the other side of the Atlantic, watch for Germany’s March industrial production data on Wednesday, the Bank of England’s interest rate decision on Thursday, and the U.K.’s first-quarter gross domestic product (GDP) report on Friday. China reports inflation data for April on Friday night while Chinese President Xi Jinping visits Europe this week, his first trip there in five years.

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of May 3, 2024.

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.

Concentration is a term used to describe the extent to which investments in a portfolio, group of portfolios, industry, sector, index, or particular geography or clustered in groups that share specific factors or other characteristics.

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.

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

Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.

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

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.

Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.

The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.

Pricing power, also known as market power, refers to a company’s ability to manipulate the price of a product or service in the marketplace by controlling the level of supply, demand, or both.

Relative performance is a measure of a security’s performance compared to a specified benchmark such as a stock index, sector or other group of similar securities.

Risk assets refer to investments such as equities, commodities, high-yield bonds, real estate, and currencies, where the value may rise or fall due to fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.

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.

“Sell in May and go away” is a saying in finance based on a historic pattern of seasonal divergence of lower relative performance for stocks from May through October.

Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing or more variable data.

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

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance. The opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.

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.

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity.

Indices
The EURO STOXX® Banks Index tracks stocks in European super sector of companies that derive their primary source of revenue from banking.

The MSCI ACWI (All Country World Index) ex USA Index captures large- and mid-cap representation across 22 of 23 developed markets countries (excluding the United States) and 24 emerging markets countries. With 2,228 constituents, the index covers approximately 85% of the global equity opportunity set outside the United States. Developed markets countries include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the U.K. Emerging markets countries include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

The MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the United States and Canada.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

 

M-542192 Exp. 9/6/2024


May 2, 2024: Disinflation delayed, not denied

Key points

  • The Fed kept its policy rate unchanged at its latest Federal Open Market Committee meeting, while showcasing its easing bias.

  • With the possibility of a potential hike effectively off the table, investors should expect rates to remain high — not higher — for longer while the Fed closely monitors incoming inflation and jobs data.

  • As earnings and key macro data releases slow, equities can grind higher with a few “catalyst-light” months ahead.

 


 

Following three stronger than expected Consumer Price Index (CPI) prints and elevated Employment Cost Index (ECI) data on the last day of April, markets went into the Federal Open Market Committee (FOMC) meeting worried about a hawkish pivot.

That’s not what happened.

“The May FOMC meeting leaned dovish, and we should breathe a sigh of relief that rates will simply remain high, not higher, for a while longer,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

The FOMC kept rates unchanged for a sixth straight meeting and, despite persistently high inflation readings to start the year, Fed Chair Jerome Powell’s comments confirmed an easing bias and essentially closed the door on a rate hike. While the Fed noted the lack of further progress on inflation, it maintained references to a future reduction of interest rates in its statement. This message was also emphasized during the press conference with mention that reducing policy restraint too late or too little could unduly weaken the economy and jobs market, and suggested that the bias to ease rates remains.

The Fed also announced that tapered balance sheet runoff will begin on June 1, with a slightly larger cut than expected to the runoff caps in the United States Treasury System Open Market Account (SOMA). Those caps will go from $60 billion/month to $25 billion/month.

Orton stressed that with hikes essentially off the table for now, it reaffirms his view that rate cuts should be viewed as when they will happen, not if. When Powell was asked whether the committee would be satisfied with inflation remaining around a 3% pace for the rest of the year, he again guided to the notion that the committee believes that the existing level of rates will be enough to get inflation down. “Of course we’re not satisfied with 3% inflation,” Powell said. “We think our policy stance is appropriate to achieve (2% inflation). The policy focus has really been on holding the current level of restriction. That’s where the discussion was focused.”


Fed holds policy rate steady for 6th consecutive meeting
U.S. 10-year Treasury yield since July 2023
U.S. 10-year Treasury yield since July 2023

Source: Bloomberg, as of 5/1/2024

Orton believes the bar to cut has gotten higher since the March meeting, and he doesn’t think even a significant surprise would put June or July back on the table for rate cuts. “December is my base case for one cut in 2024,” Orton said.

Economic alarmists also received a dose of humor and realism when Powell answered a question about the potential for stagflation by responding, “I don’t see the ‘stag’ or the ‘flation.’”

The market reaction through the early part of FOMC post-meeting communications was dovish, with implied rates and the U.S. dollar pulling back.1 Equities jumped while U. S. Treasuries gained on the statement’s lack of a more hawkish twist to forward guidance, as well as a surprisingly large cutback in quantitative tightening.

Orton didn’t like the sharp reversal in equities to close May 1 with the S&P 500 Index reversing a +1.4% move with no clear catalyst, but he said it was encouraging to see green the following morning.

“We still have the payrolls report the morning of May 3 but, hopefully, the context of the FOMC meeting will allow markets to take a strong print in stride. We should want a strong economy to support earnings growth,” Orton said. He suspects that once we get past this week, with earnings and key macro data releases slowing a bit, that equities can grind higher with a few “catalyst-light” months, and shared that election years also typically see a summer lull in volatility.

“At this point, I feel more comfortable deploying capital on market weakness, particularly to cyclical parts of the market and taking advantage of generationally attractive yields,” Orton said. He also wants to ensure it’s top of mind that sticky inflation tends to correspond to stronger-for-longer pricing power for corporations, and that better corporate profitability tends to lead to higher capital expenditures — noting that between just four of the largest mega-caps there’s nearly $200 billion being invested in the next year alone. And, he cautioned not to forget about structural tailwinds for capital expenditures such as supply chain reshoring, providing the electric needs for data center buildouts, and more.

Small-cap stocks outperformed May 1 after posting their worst monthly performance since September, with the Russell 2000® Index down 7.04%. If investors take the rate hike scenario off the table, small-cap stocks could benefit, and Orton said the entry point is interesting if you believe we’re nearing the trough in earnings. The Russell 2000® Index has lagged the S&P 500 Index by nearly 8% year to date and sits nearly 20% below its 2021 all-time high. Quality has worked well down the market capitalization spectrum and, so far, Orton said it’s been a strong year for active small-cap stock managers across styles.

“Again, this highlights the importance of being active down market capitalization,” he said, “and I believe investors who don’t have exposure to — or are underweight — small-cap stocks should consider adding some to their investment mix following this FOMC meeting.”

 

1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of May 1, 2024.

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.

The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.

Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.

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 Employment Cost Index measures the change in the cost of labor, free from the influence of employment shifts among occupations and industries, for three- and 12-month periods. The U.S. Bureau of Labor Statistics collects data for the index from thousands of private and government employers nationwide.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.

The Federal Reserve’s balance sheet is a statement of the assets and liabilities of the U.S. central bank. It shows what the Fed owns, mainly U.S. Treasury securities and mortgage-backed securities, and what it owes, mainly U.S. currency and reserve deposits of other financial institutions. The Fed’s balance sheet reflects its monetary policy and its influence on the money supply and interest rates in the economy.

Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.

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

Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.

A market-implied policy rate is an estimate of the policy rate that reflects the difference between the current policy rate and an estimated forward or futures rate.

Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.

The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.

A policy rate is an interest rate set by a central bank or other monetary authority to influence the evolution of an economy’s monetary variables such as consumer prices, exchange rates, or credit expansion.

Quantitative tightening, also known as quantitative tapering, refers to the attempt by central bankers to reverse the effects of quantitative easing (QE), which 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. In quantitative easing, buying 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. In quantitative tightening, reducing those purchases is a policy primarily aimed at interest rates and at influencing investor perceptions of the future direction of interest rates.

Stagflation, first described after the oil shocks of the 1970s, is an economic condition that includes slow economic growth (or even declines in gross domestic product), relatively high unemployment, and inflation.

Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance. The opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.

The System Open Market Account (SOMA) is managed by the Federal Reserve Bank. It contains domestic securities and foreign currency portfolios of the Federal Reserve, which are acquired through operations in the open market and serve as a management tool, liquidity resource for emergency events, and as collateral for liabilities on the Federal Reserve’s balance sheet.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

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

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

 

M-541006 Exp. 9/5/2024