Markets in Focus

Timely analysis of market moves and sectors of opportunity

Nov. 28, 2022: Is this the turn in the cycle?

There weren’t many surprises last week due to a holiday-shortened week in the United States coupled with the distraction offered by some important World Cup matches. That’s no small thing, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. He noted that following the 2010 World Cup in South Africa, the European Central Bank determined that equity trading volumes fell 55% on stock exchanges when a national team was playing and dropped another 5% when a goal was scored.

Away from the pitch, liquidity across equities and fixed income has already been poor, so Orton said he hoped that this week’s busy economic calendar, including a speech by U.S. Federal Reserve (Fed) Chairman Jerome Powell on Wednesday and payroll reports on Friday, would keep traders more tuned in. The positive price action over the past few weeks has many asset classes approaching key inflection points that will likely dictate short-term price action until the December Federal Open Market Committee (FOMC) meeting. The S&P 500 Index is approaching its 200-day moving average (DMA), which is exactly where the summer rally failed in August, while the dollar continues to break down and real interest rates test the bottom range of their consolidation channel, which is a pattern of recent trading suggesting investor indecisiveness. A continuation of these trends would be bullish, particularly for the higher duration parts of the market that have been hit so hard year to date, Orton said. Weaker economic data releases could further increase enthusiasm around the Fed pivot narrative and help the market clear some of the key technical hurdles.

“While it’s encouraging to see risk assets drawing strong interest, I do worry that there is too much enthusiasm placed on the hopes of a more dovish Fed and interest rate cuts next year,” Orton said. “My biggest concern is that investors may be starting to expect 2023 simply to be 2022 in reverse.”

This year turned out to overwhelmingly one-dimensional where the persistence of inflation dominated almost all other themes. And while Orton said it’s tempting to see 2023 in a similarly one-dimensional way, with many of this year’s themes simply shifting into reverse, he said he does not believe it will be that simple. First and foremost, even as inflation continues to decline next year, he said the extent of that decline remains uncertain. After misjudging inflation so dramatically in 2021, he said he expects that central banks will likely treat initial signs of retreating inflation with some skepticism. Additionally, the journey from 8% to 4% will be much easier than from 4% to the 2% target. That, he said, likely pushes the easing narrative further out. Second, he said, don’t forget that a downshift doesn’t necessarily mean a lower terminal rate. Minutes from the November FOMC meeting cemented Powell’s November meeting message, signaling that the coming December FOMC meeting will feature both a downshift in pace of hikes and a “dot plot” with higher dots reflecting committee members’ projections of where the terminal rate will be.

Overall, while Orton said he understands the rationale for the risk-on trade, he remains skeptical that this is a good strategic entry point to rotate into the riskier parts of the market that have been challenged year to date. Rather, he said, this is a much better market to trade or rent. We absolutely need to respect the very positive price action, he said, as the “market of stocks” continues to outperform the broader indices with the S&P 500® Equal Weight Index outperforming the S&P 500 by 2.34% since the lows on Oct. 12 (+15.14% versus +12.80%). Market breadth also is finally nearing levels consistent with a positive uptrend for the first time since January. However, markets are overbought and face a key test at their 200-day DMA. Also, the rally has largely been concentrated in the most cyclical areas of the market with materials, industrials, and financials all up about 20%. Clearly, he said, there are hopes that the macroeconomic narrative has changed and a soft landing is becoming much more popular. Additionally, information technology has staged a strong recovery with real rates consolidating, particularly semiconductors, which rallied an eyepopping 30%. Overseas, the rotation is even more obvious with European tech hardware up 40% in U.S. dollars, U.K. retail up 30%, and European auto manufacturers up 24%. The EURO STOXX 50 hit its highest level since early March following the Russian invasion of Ukraine. Yet while European equities are cheap, Orton said he is not sure a deteriorating earnings outlook and double-digit inflation provide the support necessary to get back to these levels.

There is clearly a lot hope being put into an incrementally more dovish Fed and the market can certainly continue to move higher. But Orton said he does not believe think this is the turn in the cycle.

“While I fall into the camp that we’re not going to have a severe recession, I believe it is a little too early for some of those big cyclical pockets of the market to make the types of recoveries that they have,” he said. “This is really a market to approach with a tactical mindset, and it’s one where if we do get some more downside, maybe that becomes an opportunity to start accumulating into the end of the year, especially if we see more weakness in jobs data. That would signal that the Fed could be a little lighter-handed with respect to interest rates.”

Consequently, Orton said he continues to favor maintaining a core defensive bias. That means leaning into higher quality companies. And while some investors might have FOMO — fear of missing out — when looking at the gains Orton mentioned above, he said it’s worth noting that dividend growth and growth at a reasonable price (GARP) continue to outperform the broader market. From the market low on Oct. 12, dividend growth has outperformed the S&P 500 by 357 basis points (bps) and GARP by 156 bps. Clearly, he said, being defensive has worked during a sharp rally and it has worked throughout the year during pullbacks — and we’re not out of the woods yet.

Orton said he also continues like the idea of adding exposure to U.S. small caps. Interestingly, the higher-quality index of small-cap companies, the S&P 600 Index, has actually been outperforming both the Russell 2000® Index and the broader market. Orton said this fits with his bias toward leaning into high quality. Valuations remain attractive across the U.S. small-cap complex and already capture recessionary conditions, he said.

Forecasting a mild U.S. recession

In the spirit of forecasting season, one of the most important calls relates to recession. It’s a relatively consensus view that recession looks likely in 2023, but there’s much less agreement over how severe that recession will turn out to be. The yield curve has inverted on almost every definition possible, money supply has contracted sharply, credit growth has started to slow, and it’s difficult to know the full impact of tightening measures given the long lead time for monetary policy to impact the economy. But Orton noted that the U.S. economy is supported by a relatively well-capitalized banking system, strong household balance sheets (with debt servicing costs near record lows), and a tight labor market and prolonged labor hoarding by employers. In fact, net household debt (i.e., gross debt less liquid financial assets) is at its lowest level since the late 1980s, and even the distribution of debt appears better than it has been in about 20 years. There’s no robust way to forecast the severity of recession, Orton said, but given tailwinds supporting the economy and the strong position from which the U.S. consumer and business is coming, it’s difficult to see the more severe “hard landing” coming in the future.

Watch what consumers do and what they say

Consumer spending data for the Thanksgiving/Black Friday weekend is coming in mixed, but slightly ahead of expectations. It was somewhat encouraging to see individuals continue to spend, though preliminary data point to retailers taking a bit of a margin hit with average selling prices up only 1% from last year.

Thursday’s data on personal income and spending will provide even more color on the state of the American consumer, and it also pairs well with Tuesday’s Conference Board U.S. Consumer Confidence Survey®. Together, Orton said they will allow us to assess what consumers do and say as the labor market cools down and inflation continues to weigh on their real purchasing power. The October blowout retail sales report suggests that, while spending should fade next year, it will likely be strong in the upcoming personal income and spending data. It’s also worth highlighting that we need to pay attention to the labor market gauges in the Conference Board report, particularly sub-indices of reflecting views of whether jobs are plentiful or hard to get, to better assess the ability of people to continue spending. While the jobs plentiful reading has dropped sharply over the past few months, there has been little movement in the jobs hard to get number. Orton said this is potentially a story of companies shedding openings and net hiring while continuing to hold onto existing labor given the persistent scarcity of labor supply.

Equities near a key inflection point Equities near a key inflection point

Source: Bloomberg, as of 11/25/22

What to watch

We have a busy week with updates on consumer confidence, gross domestic product, and employment. We’ll also have a number of central-bank speakers, including European Central Bank President Christine Lagarde on Monday and Jerome Powell on Wednesday. The nonfarm payroll report will be the highlight on Friday and play an important role in shaping the pivot narrative heading into the FOMC meeting later this month.

This week's data releases

Monday Australia retail sales
Tuesday U.S. Conference Board Consumer Confidence Survey®; Consumer price indexes from Germany and Spain; Japan unemployment
Wednesday U.S. gross domestic product and wholesale inventories; Consumer price indexes from the Euro area and Australia; Gross domestic product from Italy and India; Industrial output from Japan and South Korea
Thursday U.S. initial jobless claims, light vehicle sales, consumer income, construction spending and Institute for Supply Management manufacturing Purchasing Managers’ Index; Unemployment from the Euro area and Italy; U.K. manufacturing Purchasing Managers IndexTM; Gross domestic product from Brazil and South Korea
Friday U.S. unemployment and nonfarm payrolls; Japan vehicle sales; Brazil industrial output; South Korea consumer price index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

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

Consolidation in the technical analysis of market dynamics refers to an asset trading within a well-defined pattern of trading levels. Consolidation is generally seen as a sign of market indecisiveness, and it ends when the asset’s rise rises or falls outside the range of the trading pattern.

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.

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

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

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

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

The U.S. Federal Reserve dot plot is a chart summarizing the Federal Open Market Committee’s (FOMC) outlook for the federal funds rate. Each dot represents the interest rate forecasted by one of the 12 members of the committee.

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

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

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

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.

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

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

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

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

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

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

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

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

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

The South Korea Consumer Price Index, compiled monthly by Statistics Korea, measures the average change in prices for a fixed-market basket of goods and services of constant quantity and quality purchased by consumers.

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

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

The 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 EURO STOXX 50 index is a blue-chip index designed to represent the 50 largest companies in the Eurozone.

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.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data, and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor, or endorse the content of this communication.

 

RJIM22-0133 Exp. 3/28/2023


Nov. 21, 2022: Why this is no time to chase the market

Last week provided another reminder of why this is not the time to chase the market higher, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.

“This is a treading-the-water environment, he said. “It’s a great opportunity to harvest losses in the market and use that to reposition yourself going forward.”

“There remain many reasons to be encouraged by the current rally, but we cannot forget that the U.S. Federal Reserve (Fed) is ultimately driving this market, and recent ebullience may be ahead of itself since a downshift doesn’t necessarily mean a lower terminal rate,” Orton said.

Indeed, recent Fedspeak has aimed to focus market attention on the ultimate destination of policy rates ahead of the widely expected December Federal Open Market Committee (FOMC) meeting where Orton said he expects to see the downshift in the pace of rate hikes. Last week’s robust consumer spending and jobless claims data imply the economy has enough resilience at the moment to allow the Fed to proceed toward higher rates and hold them there for longer. Federal Reserve Bank of St. Louis President James Bullard made headlines on Thursday entertaining a possibility of policy rates going as high as 7%. While that would be extreme, Orton’s interpretation, consistent with other policymakers’ comments, is that the Fed is trying to deliver a message that it’s not done hiking and is trying to keep the right tail of the terminal rate extended.

Going forward, the market has a few key tests that Orton said should be watched closely for signals on where we’re likely to go into the end of the year. Internals have been very supportive with market breadth continuing to expand: 83% of S&P 500 stocks are above their 50-day daily moving average (DMA) and 54% are above their 200-day DMA. This stealth rally in the “market of stocks” needs to continue, he said, particularly as the mega-cap complex remains in a downtrend. He said it’s also important to watch the direction of real rates, which have been in a consolidation pattern since the lows at the start of October.

“If we’re to expect the current rally to be sustainable, we need to see a breakdown toward 1.25% on the real 10-year Treasury yield,” he said. “If that were to happen, I would expect momentum and low-beta stocks to show signs of truly rolling over. At that point, I think it would be time to more aggressively add risk. We’re certainly not there yet.”

Financial conditions are not leading the market Financial conditions are not leading the market

Source: Bloomberg, as of 11/18/22

The S&P 500 made a series of lower highs as financials tightened throughout the year. Orton says the recent rally from the October lows could be sustained into the end of the year only if the trend in loosening financial conditions continue.

“One of my bigger concerns,” Orton said, “is that financial conditions, in every sort of recovery, tend to lead the market. This market is leading the financial conditions, so we need to see more improvement in financial conditions going forward. We’re not going to get that until we get more clarity with respect to what the Fed is thinking and where the terminal rate is going to be.”

Quote
To expect the current rally to be sustainable, we need to see a breakdown toward 1.25% on the real 10-year Treasury yield.


Positioning in the current market

While there have been some positive developments beneath the surface, Orton said there remain meaningful headwinds for the market to reach escape velocity. While inflation has shown clear signs of peaking, wage growth and core services inflation remain at uncomfortably high levels, and Orton said he expects the FOMC to continue to voice concern over the potential for wage-price spiral dynamics. All of the “pivot” or downshift enthusiasm seems to have lost sight of the fact that Fed Chairman Jerome Powell’s main message at the November FOMC meeting was that the Fed’s “principal focus” is now the terminal fed funds rate and how long it stays there, rather than the pace of hikes. In light of that, Orton has three thoughts about positioning portfolios heading into the end of the year and beyond:

  1. Maintain a core defensive bias. Orton said he continues to believe in sticking with what has been working. That means leaning into higher quality companies. Within this, dividend growth and growth at a reasonable price (GARP) have outperformed the broader market, and he said he expects this to continue going forward. Even during the rally from the October lows, these higher quality, more defensive parts of the market have outperformed. Healthcare and energy remain the sectors he prefers most, but he said he believes new buying opportunities are growing within financials, industrials and materials.
  2. Opportunistically add to U.S. small caps. Small caps have underperformed the broader market over the past two weeks but remain in a solid uptrend. The post-Consumer Price Index bounce was historic, with more than 20% of the Russell 2000® Index jumping by more than 10%, he said and this tends to be positive going forward for index returns. Interestingly, the higher-quality index of small companies, the S&P 600 Index,has been outperforming both the Russell 2000 and the broader market. Orton said this fits with his bias toward leaning into high quality. Valuations remain compelling across the U.S. small-cap complex, he said, and already capture recessionary conditions.
  3. Tactical asset allocation is key. There has been a lot of ink spilled about the historic underperformance of the traditional 60/40 portfolio in 2022. But Orton said there hasn’t been enough emphasis placed on the fact that diversification still works: It’s just necessary to be flexible with how we seek that diversification. Such underperformance is a reminder of why being tactical with asset allocations — adjusting allocations between equities, bonds, and cash, and even within those allocations (i.e., duration, sectors, etc.) — could be the way forward, he said. There will come a time when we do see momentum truly unwind, and again it will be critical to make an adjustment and lean into the future market leadership.

What to watch

We have a holiday-shortened week and volumes are likely to be light. The economic highlight is the Fed minutes, which should shed some light on FOMC thinking. Black Friday shopping will move retail stocks and we also continue to get some important retail earnings reports that will give us more insights into the state of the U.S. consumer.

This week's data releases

Monday U.S. Chicago Fed National Activity Index; Germany producer prices
Tuesday U.S. Richmond Manufacturing Index; Eurozone Consumer Confidence Indicator
Wednesday U.S. Federal Open Market Committee minutes, initial jobless claims, new home sales, and University of Michigan Index of Consumer Sentiment
Thursday Sweden interest rate decision; ifo Institute Business Climate Index for Germany; France business and manufacturing confidence; Mexico Consumer Price Index
Friday Germany gross domestic product; Consumer confidence reports for France and Italy; Mexico gross domestic product

 

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 Carillon Tower Advisers 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.

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

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.

Core inflation, as measured by the “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy” is an aggregate of prices paid by urban consumers for a typical basket of goods, that does not include food and energy. Core CPI is widely used by economists because food and energy typically have very volatile prices. In contrast, headline inflation includes the more volatile food and energy prices.

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

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

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

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

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

Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.

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.

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

The Goldman Sachs U.S. Financial Conditions Index is designed to track the weighted average of riskless interest rates, the exchange rate, equity valuations, and credit spreads, with weights that correspond to the direct impact of each variable on gross domestic product.

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

A 60/40 portfolio is based on a widespread investment strategy calling for a portfolio allocation of 60% equities and 40% bonds or other fixed-income securities.

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

The Chicago Fed National Activity Index, released by the Federal Reserve Bank of Chicago, is a monthly index designed to gauge overall economic activity and related inflationary pressure.

The Richmond Manufacturing Index is a monthly composite index published by the Federal Reserve Bank of Richmond that represents a weighted average of the business conditions of manufacturing companies in Maryland, North and South Carolina, Virginia, most of West Virginia, and the District of Columbia. The index focuses on shipments, new orders, order backlogs, capacity utilization, supplier lead times, number of employees, average work week, wages, inventories, and capital expenditures. A rise in the index signifies improvement and growth, while a decrease in the index signifies a contraction.

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

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

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

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

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

The S&P 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 EURO STOXX 50 index is a blue-chip index designed to represent the 50 largest companies in the Eurozone.

The Credit Default Swap Index (CDX) is a benchmark financial instrument made up of credit default swaps issued by North American or emerging market companies. The index includes credits from about 125 different companies that are categorized either as investment grade or high yield. The CDX also is a tradable financial product that investors can use to gain broad exposure to the market for credit default swaps.

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.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data, and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor, or endorse the content of this communication.

 

RJIM22-0124 Exp. 3/21/2023


Nov. 14, 2022: Panic cuts both ways

There was no shortage of surprises last week, from a better than expected Consumer Price Index (CPI) report to the spectacular implosion of the FTX cryptocurrency exchange to an unexpectedly poor showing among Republicans in the midterm elections. Yet what really stood out was Thursday’s massive rally across equities and bonds following the release of the CPI and the follow-through on Friday.

“While we must respect some important changes taking place beneath the surface, it’s incredibly important to emphasize that the price action on Thursday was not healthy or normal,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “In fact, I would describe it as panic. We tend to focus on panic selling, but there can be panic buying as well. And I would consider Thursday’s massive moves across U.S. equities an example of panic buying.”

“All of this is a reminder that timing the market is a fool’s errand,” Orton said. “Those who are still sitting in cash because they were looking to call the absolute bottom have once again missed out.”

The October CPI report delivered the first downside surprise versus expectations since July (and core CPI surprised to the downside for only the third time in 12 months). Orton said he believes this paves the way for a U.S. Federal Reserve (Fed) downshift to a 50-basis point hike in December. Disinflation is finally becoming more widespread in goods sectors, suggesting that firms might be offering discounts to liquidate excess inventory, something Orton said he has been waiting to see for some time. On the other hand, while core services inflation decelerated, the details were less encouraging. Excluding rents and health insurance, core services inflation continued to print at elevated rates and will likely do so well into next year, he said.

So where does this leave us? Orton said he believes the initial leg down to 4% to 5% inflation looks readily achievable by mid-2023, but completing the journey to 2% will be much more difficult.

“This is why it’s important to remember that a Fed downshift doesn’t necessarily mean less tightening and we really need to focus on the terminal rate,” he said. Additionally, the volatility of inflation tends to rise in line with its level, meaning we should be particularly careful about extrapolating the trend from one month of data. We’ve seen consistently over the past year that every time disinflation shows up in one part of the basket, it’s been replaced by inflation in another.

So could October be a head fake? Absolutely, but Orton said he doesn’t believe it is. And that is because he would argue that monetary policy is sufficiently tight. A recent blog post from the Federal Reserve Bank of San Francisco Fed suggested that the stance of monetary policy is tighter than the Fed funds rate alone indicates. Some “shadow” measures of the funds rate have now risen to around 7%: its highest level since mid-2000. This tightening also was evident in the Fed’s Senior Loan Officer Opinion Survey on Bank Lending Practices. What’s more, Orton noted, real interest rates have recently risen into significantly positive territory across the forward curve, a clear tightening of the monetary stance.

From a positioning standpoint, Orton said we cannot ignore the breathtaking rally. Breadth was outstanding, with a 22:1 ratio of stocks rising to declining; volume was over 95% to the upside; and the number of stocks making new highs is expanding. These are all very encouraging signs, he said. If the key contributors to elevated macroeconomic uncertainty (i.e., interest rate and foreign exchange volatility, the dollar, and mortgage spreads) continue to retreat, there is scope for risk assets to continue to rally from here, at least in the short term. But he said this doesn’t change the general headwinds facing the growthiest, cash-burning companies. That’s why Orton said he prefers to stick with what has been working and to lean into dividend growth and higher quality. Growth at a reasonable price (GARP) also continues to outperform and last week hit new highs relative to the broader market. Also, he said he continues to favor U.S. small caps and adding exposure opportunistically. From a global perspective, he said emerging markets look more interesting, with scope for the rally to continue should the dollar continue to weaken. Several countries look attractive based on real rates, current account deficits, and sector trends, he said, and they include India, Mexico, Brazil, and Indonesia. Even China looks more interesting, he said.


Panic cuts both ways
S&P 500 days with increases above 5%
outside of the pandemic and Global Financial Crisis

S&P 500 days with increases above 5% outside of the pandemic and Global Financial Crisis

Source: Bloomberg, as of 11/10/22

A rare rally: The Nasdaq 100 Index
has surged by more than 6%
on only five other days in the last decade

has surged by more than 6% on only five other days in the last decade

Source: Bloomberg, as of 11/11/22

Momentum crash

Momentum naturally underperforms during turning points. Extended positioning in reflation positions had certainly raised risks of unwinds, and Orton said we saw the rug pulled out on Thursday post-CPI. No market was left untouched, but the pain trade proved particularly brutal in long dollar positions, particularly against the Asian bloc, and among single-name equities. It was tough for active managers as this reversal took place, and particularly painful for trend-following strategies. In particular, cross-sectional equity momentum strategies gave up most of their year-to-date profits in just two days (the Dow Jones U.S. Thematic Market Neutral Momentum Index was down 9% over just Thursday and Friday). The surge of momentum shorts — high-beta, highly-shorted, barely profitable growth names — was the primary driver. We must monitor whether this unwind continues, which Orton said he thinks would be problematic longer-term as it’s directly fighting the Fed.

The University of Michigan Index of Consumer Sentiment’s inflation expectations data last week was yet another reminder that we’re not out of the woods yet, he said. Both the year-ahead (5.1% vs. 5.0%) and five- to 10-year (3.0% versus 2.9%) expectations crept higher and show that inflation remains a major concern for consumers despite CPI data decelerating. To Orton, it’s just another signal to the Fed that its work isn’t done.

What to watch

This week we get important earnings results from key home improvement, big-box, and department store retailers. Orton said it will be important to pay attention to signals around the health of the U.S. consumer and how promotional the holiday season might be given bloated inventories. Outside of earnings, we have the COP27 global climate summit, Joe Biden’s first face-to-face meeting with Chinese President Xi Jinping since becoming president, the U.K.’s delayed fiscal update, and a “big announcement” from Donald Trump.

This week's data releases

Monday Eurozone industrial production; India trade, wholesale prices, and Consumer Price Index (CPI)
Tuesday U.S. Empire State Manufacturing Survey and Producer Price Index; Eurozone preliminary third-quarter gross domestic product; Unemployment from U.K. and France; China retail sales and industrial production; Germany ZEW Financial Market Survey; Japan industrial production
Wednesday U.S. industrial production and retail sales; CPI from U.K. and Canada; China property prices
Thursday U.S. housing starts and initial jobless claims; Eurozone Harmonised Index of Consumer Prices; Australia unemployment
Friday U.S. existing home sales, Conference Board Leading Economic Index®; Japan CPI

 

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 Carillon Tower Advisers or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

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

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

Core inflation, as measured by the “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy” is an aggregate of prices paid by urban consumers for a typical basket of goods, that does not include food and energy. Core CPI is widely used by economists because food and energy typically have very volatile prices.

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

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.

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

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

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

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

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

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

A current account is a measurement of the values of the goods and services a country imports and exports. Current accounts include net income, such as interest and dividends, as well as transfers, such as foreign aid.

Reflation is the act of stimulating the economy by increasing the money supply or by reducing taxes, seeking to bring the economy (specifically price level) back up to the long-term trend, following a dip in the business cycle.

A long position refers to the purchase of a security with the expectation that it will rise in value, reflecting a bullish attitude.

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

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 Dow Jones U.S. Thematic Market Neutral Momentum Index is designed to measure the performance of a long/short strategy using long positions in high-momentum companies and short positions in low-momentum companies. Momentum is calculated by ranking stocks by their 12-month historical total return, starting one month prior to reconstitution. The index is calculated using long and short indices as its basis. It is designed to be market- and sector-neutral.

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

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.

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

Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.

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

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

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

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

The Canada Consumer Price Index (CPI), released by Statistics Canada, represents changes in prices as experienced by Canadian consumers. It measures price change by comparing, through time, the cost of a fixed basket of goods and services that are divided into eight major components: Food; Shelter; Household operations, furnishings and equipment; Clothing and footwear; Transportation; Health and personal care; Recreation, education and reading; and Alcoholic beverages, tobacco products and recreational cannabis. CPI data are published at various levels of geography including Canada; the 10 provinces; Whitehorse, Yellowknife, and Iqaluit; and select cities.

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

The Conference Board Leading Economic Index® for the United States is designed to signal peaks and troughs in the business cycle, to be highly correlated with real (adjusted for inflation) GDP, and to be a predictive variable that anticipates (or “leads”) turning points in the business cycle by around seven months. It is comprised from 10 components: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; Institute for Supply Management® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Index; Leading Credit Index; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.

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

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

The Nasdaq 100® is a stock market index made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index.

 

RJIM22-0114 Exp. 3/14/2023


Nov. 7, 2022: Market leadership is changing

After a record month for the Dow Jones Industrial Average and some very strong gains across other U.S equity indices, it has been easy to get “bulled-up,” but it’s also important not to overlook what could be some important shifts in U.S. equities.

“Beneath the surface of the market, there are a lot of changes that are taking place that are really worth noting,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “What’s leading the market is changing.”

The Dow was up 14% in October, its biggest gain since January 1976, but Orton said we’re seeing now that those gains don’t mean we’re out of the woods. The gains in the Dow were specific, meaning that the record performance only occurred in the Dow. The S&P 500 Index posted strong gains of 8.8%, but it was only the best month since July. Same story for the MSCI ACWI® (All Country World Index): It was up 6%, but that’s only its best month since July. In reality, the “record” October was a story about U.S. large-cap energy (+21% month over month), banks (+12.8%), and industrials (+12.5%).

“And the fragility of the rally was on full display as the market digested the Federal Open Market Committee (FOMC) meeting and financial conditions that refuse to roll over,” Orton said. “This is a great example of why I don’t think it’s appropriate to be chasing upside right now and why it continues to be so important to maintain a core defensive bias as volatility dominates the price action.”

Quote
There are some very interesting opportunities. They just look quite different from the leaders of the past decade.


The takeaways from the November FOMC meeting were mixed as the official communique ultimately proved to be in conflict with the broader messaging. The actual statement signaled a coming downshift in the pace of rate hikes, but Fed Chairman Jerome Powell’s message in the subsequent press conference took a different turn. He emphasized that while the Fed sees a downshift in the pace of hikes as appropriate “as soon as the next meeting or the one after that,” the FOMC simultaneously sees a higher terminal rate compared to its prior meeting, and that “it is very premature to be thinking about pausing.” Given some very clear signs of labor normalization and early economic weakness, Orton said he is once again not sure why Powell is using such strong language around ultimately pausing rate hikes.

“Remember last year when the Fed wasn’t thinking about thinking about raising rates?” he said. “That hasn’t aged well, and I can only hope that’s not the case this time. There’s just no need to back yourself into a corner.”

Investors also are too focused on the when the downshift occurs, and not enough on the risks of a higher terminal rate for longer, Orton said. Powell gave a very clear hint that the Fed is set to project a terminal rate at the December FOMC meeting higher than the September FOMC median dot plot of 4.75%. Powell also reiterated the Fed’s continued focus on inflation expectations, so Orton said the University of Michigan five- to 10-year inflation expectations data on Friday will be particularly important for the market.

With all of these cross-currents posing very real challenges to the market, there are also some positive developments worth highlighting, Orton said. Beneath the surface, the “market of stocks” continues to strengthen even though the major indices remain at the mercy of deteriorating mega-cap stocks. The S&P 500® Equal Weight Index is outperforming the cap-weighted index by more than 300 basis points (bps) quarter to date (+8.49% versus +5.30%), and it’s outperforming the Nasdaq Composite Index by more than 900 bps (+8.49% vs. -0.96%).

“If we look past mega-cap growth, which is making new relative lows, the world is not that bleak,” Orton said. “It’s bad, but not as bad as headlines suggest.” Non-growth and smaller-cap stocks are doing well, led by strength in healthcare, industrials, financials, and energy. Overseas, Latin America is once again breaking out, India is hitting new highs, European banks are breaking out from a multi-month base, and even China got a little bit of relief on hopes that zero-COVID policies will be loosened, though Orton cautioned that any hopes of a major turn on Chinese policy are premature.

“All of this is to say there are some very interesting opportunities; they just look quite different from the leaders of the past decade,” he said. “It also puts the onus on us to be very careful and avoid catching a falling knife.”

Orton’s playbook: Stay defensive, lean into small caps

From a positioning standpoint, Orton said he continues to believe in maintaining a core defensive bias — leaning into quality, dividend growth, and growth at a reasonable price (GARP) — as well as U.S. small caps. He said it’s worth pointing out that over the last month quality and value were the two strongest-performing factors across global equity markets. Investors are still looking for the security of strong and stable profits and cash flows ahead of an anticipated recession. Cheap and growing earnings have also been rewarded. This helps to contextualize why healthcare and energy continue to perform well and why Orton favors both sectors going forward. While there are some very interesting opportunities at the stock level, he said it’s still difficult to wade into higher beta areas of the market given the macroeconomic backdrop. The October jobs report is just the most recent piece of economic data that continues to paint a cloudy picture. It showed a lot more resilience in the labor market than one might otherwise surmise from the steady string of layoff announcements and hiring freezes dominating recent headlines. The economy is certainly slowing, and the labor market is following suit — but at least as of October, the continued hiring momentum will challenge policymakers looking to meaningfully downshift.

Is there a stealth bull market starting? Is there a stealth bull market starting?

Source: Bloomberg, as of 11/4/22

Labor market is bending, not breaking
Labor market is bending, not breaking

Source: Bloomberg, as of 10/31/22

Initial signs of a reversal in rate volatility
Initial signs of a reversal in rate volatility

The MOVE Index, which measures U.S. interest rate volatility, dropped below its 50-day daily moving average last week. If this trend continues, Orton said it would help ease macroeconomic uncertainty: one of the key headwinds to risk assets.

Source: Bloomberg, as of 10/28/22

Orton said he also continues to favor increasing allocations to small caps, which have been outperforming the broader market for a little while now. Interestingly, despite a strong October for the Russell 2000® Index and weakness in the Top 5 stocks in the S&P 500, they still trade at 6.5 times revenue versus 2.2 times for the Russell 2000. The Top 5 are also nearly three times the size of the Russell 2000, so there is clearly still room for normalization, he said. It’s worth noting that earnings season has been better down market-cap and valuations remain compelling. The drivers of small-cap outperformance have also been healthy. It has been driven by the lowest price-to-earnings (P/E) ratio names, the fastest-growing stocks based on revenue, as well as by higher quality companies. Cyclicals also continue to beat secular growth, which will remain challenged until we get to a pause in rate hikes. Flows still remain anemic into small caps, which can provide a strong tailwind should they pick up.

Changing market leadership?

During October, there were indications that there might be a shift beneath the surface of the equity market, Orton said. And this change is evident in the underperformance of the mega-caps as well as in growthier companies in general. The beta factor has been underperforming, and we have not seen higher-beta stocks rally in line with the bounce in equity markets. In fact, the beta factor actually declined.

“Prior to this fall, whenever the market bounced, it would be led by growth and by the highest-beta names that sold off hard earlier this year,” Orton said. “But what we’re seeing now is that high-beta and growth names are lagging as the market moves higher. Instead, what is leading the market are more defensive names. You’re seeing cyclicals move. You’re seeing financials, industrials, and healthcare not only outperform on the way down and provide protection, but they’re leading on the way up as well. You’re actually seeing value and quality as factors leading the market higher. It’s very rare to see both of those working together. The last time we saw that was after the Tech Bubble and it persisted for quite a long time. If we have that sort of change in leadership like we saw in the early 2000s, this rotation in leadership for the market could have legs to it.”

This breakdown is still in its early days, he said, but if it’s sustained then the leadership in the U.S. market might be changing.

“This could suggest that the stealth bull market in the ‘market of stocks’ can be sustained,” he said, “and that should be welcome news to stock pickers who are focused on valuations and cheap growth.”

What to watch

U.S. elections on Tuesday likely will steer some attention away from investors who have been singularly focused on the Fed, but Orton said that won’t last too long with the U.S. Consumer Price Index reported Thursday and the University of Michigan Index of Consumer Sentiment on Friday.

Earnings slow down but continue with some important reads on the consumer from companies in entertainment and theme parks; video games; electric vehicles; clothing, fashion, and luxury goods; cruise lines; home construction; e-commerce; investment management; semiconductors; energy; chemicals; and phosphate mining.

This week's data releases

Monday Germany industrial production; China trade
Tuesday U.S. elections; Household spending reports from Japan and Australia; Japan Leading Economic Index; Eurozone retail sales
Wednesday U.S. wholesale inventories, Mortgage Bankers Association applications; U.K. home prices; Japan balance of payments and bank lending; Brazil retail sales; Consumer Price Index (CPI) reports from Mexico and Russia
Thursday U.S. CPI and initial jobless claims; CPIs from Brazil, Norway, Denmark, and Greece; Italy industrial production; Bank interest rate decisions from Mexico and Peru
Friday University of Michigan Index of Consumer Sentiment; U.K. gross domestic product and industrial production; Germany CPI; Japan producer price index

 

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

Diversification does not ensure a profit or guarantee against loss.

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

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

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

The terminal rate is the rate at which the U.S. Federal Reserve stops raising the federal funds rate in an attempt to bring down inflation. The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the 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 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.

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

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

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

The 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.

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

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

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

Factor investing is an approach to investing that selects securities based on characteristics associated with higher returns. These characteristics, or factors, can be macroeconomic factors or style factors. Macroeconomic factors are focused on broad risks across asset classes and include the rate of inflation: growth in gross domestic product; and the unemployment rate. Style factors include differences in growth versus value stocks; market capitalization, and industry sector. Factor performance refers to a focus on performance of securities within a particular factor or between groups of different kinds of factors.

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

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

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.

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.

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 Japan Leading Economic Index, released by the Cabinet Office of the national government of Japan, tracks economic indicators in more than a dozen categories, including inventories, new job offers, machinery orders, housing construction, consumer confidence, stock prices, money supply, the investment climate, operating profits in manufacturing, government bond yields, and sales forecasts for small business.

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

The Japan Balance of Payments Current Account, issued by the Bank of Japan, measures the size of the trade surplus or deficit in goods and services between Japan and the rest of the world and summarizes factors accounting for changes in the balance.

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

The Russian Consumer Price Index, according to the Organisation for Economic Co-operation and Development, measures inflation as defined by the change in the prices of a basket of goods and services that are typically purchased by specific groups of households. Inflation is measured in terms of the annual growth rate and in index, 2015 base year with a breakdown for food, energy and total excluding food and energy.

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

The Norway Consumer Price Index, released by Statistics Norway, tracks the development in consumer prices for goods and services purchased by private households in Norway, and is a common measure of inflation. The CPI adjusted for tax changes and excluding energy products (CPI-ATE) is a measurement of the underlying growth in consumer prices.

The Denmark Consumer Price Index, released by Statistics Denmark, measures the development of the prices charged to consumers for goods and services bought by private households in Denmark.

The Greece Consumer Price Index, compiled by the Hellenic Statistical Authority, measures the general level of prices of goods and services purchased by the average Greek household. CPI prices are collected in 27 cities with representative markets for the coverage of the 13 regions of the country. The selection criteria of the price collection cities are the size and the particularities of their markets, the possibility of continuous price collection, the comparability of the index, and the cost of price collection.

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

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

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

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

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.

 

RJIM22-0102 Exp. 3/7/2023