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”Markets in Focus
Timely analysis of market moves and sectors of opportunity
The U.S. Federal Reserve is looking for signs of whether the current disinflationary trend is sustainable.
Meanwhile, consumers have persistently elevated inflation expectations.
After months of underperformance, some market sectors are starting to look appealing.
The road to 2% inflation will likely be bumpier than the market expects, said Joey Del Guercio, Market Strategy Analyst at Raymond James Investment Management, but patience and a focus on selecting higher-quality stocks could help smooth the ride.
Last week’s release of Federal Open Market Committee (FOMC) minutes offered insights into the decision to hold rates steady at its Oct. 31-Nov. 1 meeting. Del Guercio summarized committee members’ thinking: “At the time, officials were concerned about the tightening credit standards caused by this historically rapid rate-hiking cycle. They were also wary of an anticipated increase in consumer-loan delinquencies.”
The U.S. Treasury 10-year yield has fallen by more than 50 basis points since the Oct. 31-Nov. 1 decision to pause interest rate increases, and financial conditions have generally softened. However, Del Guercio believes that the U.S. Federal Reserve (Fed) is likely to maintain its tightening bias and hold rates steady, until it can trust that the disinflationary trend is sustainable.
“Just last week, despite gas prices continuing to edge lower, the University of Michigan Index of Consumer Sentiment showed that consumers had persistently elevated inflation expectations,” Del Guercio said. The median year-ahead inflation expectation rose to 4.5% in November, up from 4.2% in October, which is its highest level since April of this year. Del Guercio also noted that the consumer’s average 5- to 10-year inflation expectations were revised up to 4.8%, which is the highest they have been since May 1996.
All eyes were on corporate earnings reported by a major tech company last week as investors looked for insights into this rally’s durability. The S&P 500 Index’s largest companies by have contributed nearly all the market’s year-to-date gains, and it was very important to see them continuing to drive returns. “Despite the S&P 500 and Nasdaq Composite Index’s respective year-todate performances, the rest of the market has struggled this year,” Del Guercio said. “The gap between winners and losers remains wide, but we’re starting to see more companies join the party.”
Participation in this rally continues to expand
Percentage of index members above their 50-day moving average
Source: Bloomberg, as of 11/24/23
Del Guercio said that after the market’s rosy reaction to the Nov. 14 Consumer Price Index (CPI) data, some of this year’s most beaten-down corners of the market have outperformed. Within the S&P 500, the real estate sector is up 6%, and other year-todate laggards – such as utilities, materials, and financials – all outperformed the broader index.
“After months of underperformance, interest-rate sensitive sectors also outperformed following this year’s steep hikes,” Del Guercio said. Small caps, regional banks, and even speculative growth stocks have all markedly outperformed the S&P 500. “Is this the beginning of a sustainable widening in market breadth, or just a snap reaction to promising CPI data?”
The year’s losers outperform tech and the overall index
S&P 500 sector returns since Nov. 14 CPI release
Source: Bloomberg, as of 11/24/2023
Quality, growth at a reasonable price (GARP), and selectivity. Del Guercio believes that quality should continue to permeate all investment decisions. “Look to invest in companies with attractive returns on equity, robust free cash flows, and strong balance sheets,” he said. “The highest quality companies should generally be less susceptible to deep drawdowns if tail risks materialize.” Del Guercio also advised against crowding into popular growth trades that have outperformed year to date. “Be patient and opportunistic in adding beta by leaning into growth at a reasonable price.”
Potential rotation opportunities in small-cap stocks and energy. “Small caps have been a terrible place to be this year,” Del Guercio said, “but their historic underperformance can’t persist forever.” He suggested practicing patience and being opportunistic in looking for quality small-cap investments, noting that selectivity is far more important in the small-cap space; the Russell 2000® Index is loaded with non-earners and lower-quality companies. “Energy has lagged the broader market since the CPI release, but the improving performance of high-quality companies has had an outsized impact this sector, and it has been historically correlated with real rates, which I believe will remain elevated for the foreseeable future,” he said.
Lean into the mega-trends. Economic growth is undeniably slowing into 2024. “Amid so much macro noise, investors have much to pay attention to,” Del Guercio said. He recommends leaning into the long-term megatrends that will shape the investment landscape of the future: Artificial intelligence, the energy transition, reshoring and the capital expenditure cycle, and an aging U.S. population that is expected to need treatment for a larger number of chronic illnesses.
The upcoming week could provide some clarity on inflation. October’s Personal Consumption Expenditures (PCE) Price Index, excluding food and energy – also known as the core PCE price index, the Fed’s preferred inflation metric – will be published on Thursday morning, providing key data for the FOMC and the market that will hopefully make the trajectory of inflation and financial conditions a bit clearer.
On Monday, the U.S. Treasury is auctioning off 2-year and 5-year notes, as well as a 7-year note auction on Tuesday, which should assist in further gauging investor interest. Monday will also provide a refreshed view of home sale data, followed by the S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index on Tuesday and pending home sale data on Friday.
The U.S. Consumer Confidence Survey® comes out on Tuesday, with additional data on personal income and consumption released on Thursday. Data on initial jobless claims and motor vehicle sales will be released on Friday. Finally, economic growth will be under the magnifying glass with the Fed releasing its Summary of Commentary on Current Economic Conditions by Federal Reserve District on Wednesday. The U.S. Bureau of Economic Analysis will also release its second estimate for thirdquarter gross domestic product (GDP) on Wednesday, followed by construction spending data and manufacturing information from the Institute for Supply Management on Friday.
Risk Information:
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
Disclosures:
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Definitions:
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%.
Beta is a measure of the volatility or systemic risk of a security, group of securities, or portfolio compared with the market as a whole.
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.
Core measures of inflation or other economic activity exclude food and energy prices. Economists and other market participants regard core measurements as a more reliable measure of inflation trends than headline readings, also known as nominal inflation, that do include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index.
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.
Dovish, hawkish and centrist are terms used to describe the monetary policy preferences of central bankers and others. 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.
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.
Growth at a reasonable price (GARP) is a stock investment strategy that seeks to combine tenets of both growth and value investing in the evaluation and selection of individual stocks. GARP investors look for companies with consistent earnings growth above broad market levels but try to avoid companies with very high valuations. By trying to avoid the extremes of either growth or value investing, GARP investors often end up focusing on growth-oriented stocks with relatively low price-to-earnings multiples in normal market conditions.
Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
Mega-cap tech stocks are the technology companies with market capitalizations that are in the trillions or hundreds of billions of U.S. dollars, levels that far exceed many of the other stocks in the S&P 500 Index.
The Personal Consumption Expenditures (PCE) Price 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.
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.
A real interest rate, or yield, is an interest rate that has been adjusted to remove the effects of inflation. In contrast, a nominal interest rate is one that has not been adjusted to remove the effects of inflation. Once adjusted, the real interest rate 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.
Reshoring describes the effort to bring manufacturing and other services back to the United States from overseas operations.
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.
The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measure the value of residential real estate in 20 major U.S. metropolitan areas: Atlanta, Boston, Charlotte, Chicago, Cleveland, Dallas, Denver, Detroit, Las Vegas, Los Angeles, Miami, Minneapolis, New York, Phoenix, Portland, San Diego, Francisco, Seattle, Tampa, and Washington, D.C.
The U.S. Federal reserve’s Summary of Commentary on Current Economic Conditions by Federal Reserve District, commonly known as the Beige Book, is published eight times per year. The summary gathers anecdotal information on current economic conditions through reports from bank and branch directors and interviews with key business contacts, economists, market experts, and other sources.
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.
The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continenal 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 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.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
Indices:
The Nasdaq Composite Index includes almost all stocks listed on the Nasdaq stock exchange.
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 10% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a 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-462984 Exp. 3/27/24
