“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
Tightening financial conditions, particularly rising real rates, have put pressure on equities.
Real sales growth this quarter is negative for S&P 500 Index companies thus far, and forward guidance has largely disappointed consensus.
Weakness due to macroeconomic uncertainty has created a number of opportunities, but selectivity matters more than ever.
It has been a difficult few weeks for investors as the stock market followed the broader market of stocks into correction territory. The S&P 500 Index is now down -10.3% from its July 31 peak while the S&P 500® Equal Weight Index is down -13.8%. But even these figures mask the true pain that has been felt across the broader market over the past few months, according to Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
“Small-cap equities are in a world of pain after breaking below their lows of last year,” Orton said. “The Russell 2000® Index is nearly 20% off its July highs — not a good harbinger for recovery, even as historic valuation discrepancies keep growing.” He added that more than 70% of companies in the Russell 3000 Index are now in a bear market along with more than 40% of the companies in the S&P 500 Index.
Tightening financial conditions, particularly rising real rates, have put pressure on equities. Real yields on 10-year U.S. Treasuries briefly crossed 4.5% last week, which was the U.S. Federal Reserve’s (Fed’s) target for the end of 2024.
“I just can’t help but think the recent moves are overextended and compounded by pervasive pessimism and an unwillingness on the part of investors to step in front of the rising rate freight train,” Orton said. “I would agree, but I also can’t help but feel like the risk-reward pendulum has swung too far across some very high-quality assets.” Orton said that market corrections are perfectly normal, and they’re also always followed by a recovery. “I don’t know if this pullback is complete,” he said, “and any recovery attempt should be judged skeptically until market breadth starts improving.”
However, Orton pointed out that investors who have leaned into quality have outperformed. “I expect this to remain the case until the market finds its footing,” he said. “As painful as the going is, this too shall pass. Weakness due to macroeconomic uncertainty has created a number of opportunities, but selectivity matters more than ever.”
In addition to elevated macroeconomic uncertainty, investors have also had to contend with mixed messages from earnings results. “Last week was the busiest week of earnings season,” Orton said, “and while the results were generally solid, management outlooks weren’t ‘good enough’ given the macroeconomic backdrop.” He added that this was especially true for mega-cap companies that had already posted impressive share price gains throughout this year. “The blended earnings growth rate for the third quarter stands at +2.7%, versus expectations of -0.3%, and nine sectors have beaten expectations and posted upward revisions to estimates.”
Energy is the biggest drag on overall earnings, due to difficult comparisons with last year, and Orton said that excluding the sector from the blended S&P 500 earnings per share growth rate would increase it to 8.4%. “On the other hand, real sales growth is negative, and for every company that guided sales above consensus, five guided below,” he said.
“Investors have focused on mixed guidance, but I would point out that margins have inflected positively with the blended net profit margin now at 12.0%, above last quarter’s profit margin of 11.6% and above the five-year average of 11.4%,” Orton said. “While sales guidance has been weak, earnings per share guidance has held up better because margins are expected to remain strong in the coming quarters.”
Orton believes that multi-standard-deviation reactions to good results, and a cautious revenue outlook, highlights the extreme nature of the current pullback. This could create some compelling opportunities as the market recovers.
“I think the main takeaway from the price action lately is uncertainty,” Orton said. “With severely elevated levels of rate volatility and weakness in the ballast provided by the mega-caps, it’s tough to want to take much risk, especially in advance of critical economic data reports and the November Federal Open Market Committee meeting.”
Orton said that investors could be excused for thinking a rate hike is on the table this week after the U.S. gross domestic product (GDP) came close to 5% in the third quarter and nonfarm payroll growth proved resilient through September. Instead, he said that Fed officials have strongly signaled that the recent tightening in financial conditions may mitigate the need to do more with rate hikes.
“In order to re-engage with hikes,” Orton said, “I would look for Fed Chair Jerome Powell to cite specific circumstances, including a destabilization of inflation expectations, stalled progress on the path toward 2% inflation, or the lack of a ‘persistent’ tightening of financial conditions.”
Orton noted it was possible that a confirmation of the Fed’s messaging on Wednesday could provide a catalyst for the market to move higher. “With key technical levels having been breached, I’d rather be a bit late to the recovery and wait for confirmation than backing up the truck right now,” he said.
The S&P 500 Index tends to follow financial conditions
Source: Bloomberg, as of 10/27/23
Source: Bloomberg, as of 10/27/23
Orton said that the market drawdown has been somewhat unique in that defensive sectors have underperformed meaningfully. “Since the start of the pullback on July 31, utilities and staples have underperformed the broader market,” he said, “though last week we finally saw them provide some insulation. Interest rate sensitivity puts these sectors in the penalty box, and a general lack of strong earnings momentum has also kept investors away.”
Given a still-benign economic backdrop, Orton said that he would advocate for leaning away from defensive sectors and instead looking for opportunities in sectors and industries that are more exposed to meaningful secular mega-trends. “Sector dispersion also remains incredibly elevated, which highlights that sector positioning has provided a significant source of alpha,” he said. “It’s also yet another reminder of the importance of tactical asset allocation in such a rapidly shifting market.”
Given the significant sector dispersion and extreme narrowness of the market, Orton sees some very interesting opportunities beneath the surface. “Some of the top performing companies are indeed high quality with strong balance sheets, earnings momentum, and free cash flow generation,” he said. “But there are other high-quality companies trading at meaningful discounts where we’re seeing earnings reaccelerate, and they aren’t overly exposed to some of the drivers of macro uncertainty, such as concerns over the consumer.”
Orton believes that investors should have their shopping lists ready for when markets start to see a sustainable recovery:
Rotation opportunities in energy, industrials, and healthcare. The energy sector took a big hit on Friday after weak results were reported by some of the largest oil companies, and their earnings per share growth numbers were the biggest detractor from the S&P 500 Index. However, Orton said that some areas look quite attractive, including equipment & services where earnings per share growth is coming in at +21%. “Next quarter, we’ll also be passing some of the most difficult comparisons with previous years, and valuations remain quite attractive with upward analyst revisions,” he said. Orton believes that this sector often looks attractive when the market dips due to its positive correlation to real rates.
Selectivity in emerging markets. Emerging markets are in a tough place given the strong dollar and the impact of rising rates. China further adds to the pressure at the index level. But look beneath the surface and there are some interesting opportunities, Orton said. He has long favored India, and he said the region continues to hold up quite well with broad market participation. Positioning is light from a global investor perspective and India benefits from some of the key megatrends like supply chain diversification as multinationals rethink their global footprint. Massive infrastructure spending to support this coupled with a burgeoning consumer class also provides long-term growth tailwinds.
Within healthcare, Orton noted that glucagon-like peptide 1 (GLP-1) drugs have caused big distortions. “Evidently, consumers won’t need insulin pumps or knee replacements anymore, which led many medical device companies to get taken to the woodshed,” he said. Orton believes that speculation around the secondary impacts of obesity drugs are excessively overstated, which has created what he views as some nice entry points. “Overall, the impact of an aging population and the need for increased efficiency supports many companies across the healthcare value chain,” Orton said.
Industrials have also been an underperformer lately, but Orton said that dispersion has been high and there are plenty of high-quality companies with a premium return on equity and attractive valuations that will benefit from a structural pickup in capital expenditures.
Selectivity in emerging markets. “Emerging markets are in a tough place, given the strong dollar and the impact of rising rates,” Orton said. He also acknowledged that China has added to market pressures at the index level, but he believes that some very interesting opportunities lie beneath the surface. “I have long favored India,” he said, “and the region continues to hold up quite well with broad market participation.” Positioning is light from a global investor perspective and India benefits from some of the key megatrends like supply chain diversification as multinationals rethink their global footprint. Massive infrastructure spending to support this, coupled with a burgeoning consumer class, also provides long-term growth tailwinds.
Lean into value in Japan. “Japan has sold off, along with everything else, but it has continued to outperform global equities,” Orton said. The nation has benefitted from higher for longer interest rates as it manages its exit from deflation, and the Bank of Japan has provided a catalyst this week. “Rising asset flows and inflation provide support for growth and investments while structural changes are helping to increase shareholder-friendly actions and better capital allocation,” Orton said. Despite a strong year-to-date rally, he believes that valuations sitting around their long-term median are still reasonable. “I favor leaning into value sectors, given their leverage to rising rates,” he said. Orton also prefers to underweight defensive sectors.
“It seems like every week has some sort of ‘critical’ data point, but this week we get a lot of them in rapid succession,” Orton said. U.S. Federal Reserve (Fed), Bank of England (BoE), and Bank of Japan (BoJ) meetings occur this week along with the U.S. Treasury refunding announcement. “I expect the Fed and the BoE to keep rates unchanged, but there’s a high chance that the BoJ raises its ceiling on the 10-year rate from 1.0% to 1.5%,” Orton said. “Perhaps we’ll get just a small respite from rate increases if the Fed keeps interest rates on hold, even if there is a hawkish message from Powell.”
Other potentially market-moving reports include the ADP® National Employment Report™, the U.S. Bureau of Labor Statistics Job Openings and Labor Turnover Survey (JOLTS), and the Employment Situation Summary tracking nonfarm payrolls. Additional earnings releases could provide more insights into the state of the consumer and the remaining mega-cap companies.
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.
Definitions:
The ADP® National Employment Report™ is published monthly by the ADP Research Institute® in close collaboration with Moody’s Analytics. The ADP® National Employment Report™ provides a monthly snapshot of U.S. nonfarm private sector Employment based on actual transactional payroll data.
Alpha is a measure of the difference between a manager’s actual returns and its expected performance, given its level of risk as measured by Beta. A positive Alpha figure indicates the manager has performed better than its Beta would predict. A negative Alpha indicates the manager performed worse than expected based on its level of risk. Thus it is possible for a manager to outperform an index and still have a negative Alpha. In general, however, the higher the Alpha the better.
Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.
Breadth/narrowness 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.
Correlation is a statistic that measures the degree to which two securities move in relation to each other. 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.
Dispersion of performance refers to how much the returns of individual stocks vary from their collective average. It increases as the spread between highs and lows widens.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
Emerging markets describe economies of developing nations that are becoming more engaged with global markets as they grow. Emerging market economies generally have some but not all of the characteristics of a developed market, which include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.
The payroll report, known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.
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.
Glucagon-like peptide 1 (GLP-1) agonists comprise a class of type 2 diabetes drugs that improve blood sugar control and may also lead to weight loss. The drugs mimic the action of a hormone called glucagon-like peptide 1 by stimulating the body to produce more insulin when blood sugar levels start to rise after someone eats. The additional insulin helps lower blood sugar levels, which helps in controlling type 2 diabetes. How GLP-1 agonists lead to weight loss is less clear.
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.
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 Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics.
Market of stocks is a term market participants use when referring to the diversity of technical or other characteristics that may exist at any given time within the overall stock market. For example, the stock market as a whole may rise or fall on the fortunes of a small number of very large and thus very influential stocks. But within the broader market of stocks, there can be many companies with performance, risk, or opportunities that vary significantly from what market participants may find at the index level.
The median represents the mid-point of within a range of data points.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
Quality investing is a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance, as reflected in financial metrics such as ratios of return to equity and debt to equity, as well as to earnings variability.
The real rate of return is the annual percentage of profit earned on an investment, adjusted for taxes and inflation. Real returns are lower than nominal returns, which do not subtract taxes and inflation.
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.
Refunding is the process in which an issuer of fixed-income securities such as bonds retires some of its outstanding callable bonds and replaces them with new bonds. Issuers refund bonds to reduce financing costs by replacing the old bonds with new ones that have more favorable terms to the issuer.
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.
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.
Standard Deviation is a measure of the dispersal or uncertainty in a random variable. For example, if a financial variable is highly volatile, it has a high Standard Deviation. Standard Deviation is frequently used as a measure of the volatility of a random financial variable.
A tactical asset allocation model is an approach to investment portfolio management that entails shifting asset allocations within a portfolio in response to risks and opportunities presented by macroeconomic conditions, market trends, or other events.
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 S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The 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.
The Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 96% of the total market capitalization of all U.S. incorporated equity securities.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-450445 Exp. 2/28/2024
Large recent swings in 10-year Treasury yields have heightened equity volatility, depressed investor sentiment, and swelled outflows from virtually all parts of the stock market.
Rising real rates are a contributor to the extreme narrowness of the stock market.
Be cautious but ready to take what the market gives. It’s worth remembering that earnings are improving and, with some notable exceptions, have looked good so far. Still, earnings this week will be critical.
The relentless rise of longer-dated interest rates continues to pressure the market, fueling volatility and highlighting the importance of selective investment, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
Last week, yields on 10-year U.S. Treasuries posted their biggest weekly advance of 2023, rising more than 30 basis points (bps) and almost touching 5%. If it feels like the swings in rates this year have been extreme, that’s correct. Last year, there were 23 weeks when the 10-year Treasury yield moved more than 20 bps – a record over the past two decades – and 2023 is on track to be nearly as extreme.
“These large moves are finally feeding into elevated equity volatility, further depressing investor sentiment, and leading to increased outflows across nearly all parts of the equity market,” Orton said.
These developments further compound recent challenges for the equity market, which is already dealing with historically bad breadth. The relative strength of the mega-cap complex has masked weakness across the rest of the market, which is only getting more extreme as small caps break down and re-test the lows of last October. This week will be a major test for the market with critical earnings reports from four of the biggest companies.
“Any additional pressure at the top could cause what has been a stealth bear market to come into the open,” Orton said. The divergences between the broader S&P 500 Index and the S&P 500® Equal Weight Index as well as the Russell 3000® Index are getting too extreme. However, he added that there are still a number of positives that investors should not ignore, particularly around earnings growth in specific sectors and industries.
“Right now it makes sense to be cautious but to take what the market gives us, because at the end of the day, earnings are still improving and have looked pretty good so far,” Orton said. “The key is to lean into quality – profitability, earnings growth, free cash flow, lower leverage – across all investments going forward. The weakness due to macroeconomic uncertainty has created opportunities, but selectivity matters more than ever.”
Number of weeks where the 10-year Treasury yield moved 20 or more bps
Source: Bloomberg, as of 10/20/23
Interest rate volatility vs. equity volatility
Ratio of ICE BofA MOVE Index to the CBOE Volatility Index (VIX)
Source: Bloomberg, as of 10/20/23
The market has narrowed since the lows following the collapse of Silicon Valley Bank in early March, and recently this lack of breadth has become quite pronounced. A major contributor to the current narrowness is not wild speculation, Orton said, but the rise in interest rates and bearish trends from regional banks. Regional banks represent a small number of stocks in the S&P 500, but they make up 11% of the Russell 2000® Index and 6.5% of the broader Russell 3000 Index.
“We don’t need the complex to take off,” Orton said. “It just needs to stop moving lower to help stabilize the broader market. Rates will play an important role in that, but there hasn’t been a clear sign that rates have peaked.”
The structural trend for higher longer-term yields has been in place since May with 10-year Treasury yields higher by roughly 150 bps. In the last two months, this move has accelerated as U.S. economic data has remained resilient and the “higher-for-longer” narrative has sustained the bear-steepening trend. Unfortunately, Orton said it’s not clear that we’ve seen a peak in the move higher given the continued increases in Treasury supply due to large deficits and ongoing quantitative tightening, coupled with marginal buyers of Treasuries being much more price-sensitive.
Volatility also has been extreme at the back end of the curve. Using the S&P 500 and the iShares 20+ Year Treasury Bond ETF (exchange-traded fund) as proxies for equity and longer-dated rate volatility, the long-dated bond ETF out-realized the S&P 500 by 18 volatility points (28 versus 10) over the 10 days ending Oct. 20.
“There’s never been a spread so large,” Orton said. “This highly elevated rate volatility adds a financial component to the economic risk associated with higher for longer monetary policy.”
Another challenge with elevated cross-asset volatility is the breakdown we have seen across the traditional correlation relationships to which we’ve become accustomed. Stock-bond correlation and the 60/40 portfolio have been front and center, but many other asset classes have been impacted. The relationship of gold to Treasuries and the dollar also has been shifting.
“I have heard it suggested that these shifting correlations across asset classes are a harbinger of something quite pernicious that will unfold,” Orton said. “That said, I’m still waiting for that recession, the earnings apocalypse, and deteriorating corporate margins. I do believe, however, that some of this reflects the unwinding of the extreme monetary conditions that persisted for the past 13 years and fundamentals driving individual asset classes.”
This means gold should do well amid heightened geopolitical uncertainty despite elevated real interest rates, he said. It also means U.S. equities can hold up as long as earnings, margins, and consumer spending hold up despite the jump in rates. If anything, Orton said these changing correlations should be seen as a reason to make tactical asset allocation decisions. “This is a great time for talented portfolio managers to earn their keep,” he said.
What is clear is that the narrowness of the market has become quite extreme, and there are some interesting opportunities beneath the surface, Orton said.
The equal-weight S&P 500 index is negative on the year while the recent weakness outside of communication services and information technology has left the spread between the bestand worst-performing sectors in the cap-weighted S&P 500 at 60.4%. Some of the top-performing companies are indeed high-quality with strong balance sheets, earnings momentum, and free cash flow generation. But there are other high-quality companies that are trading at meaningful discounts as earnings re-accelerate and that aren’t overly exposed to some of the drivers of macroeconomic uncertainty such as concerns over the consumer. Orton’s key investment themes during this time of uncertainty include:
Rotation opportunities in energy, industrials, and healthcare. Energy continues to look attractive and is just about the only sector that has worked over the past few months. Despite this relative strength, valuations remain attractive and we’re seeing analysts continue to revise their expectations higher. Earnings should re-accelerate after this quarter as oil prices reset higher and we move past the most difficult comparisons to last year. Don’t forget about the added benefit of being positively correlated to real interest rates.
Within healthcare, earnings have started on a positive note from health maintenance organizations and valuations broadly have come down while earnings are largely underappreciated in higher-quality parts of the sector. The impact of an aging population and the need for increased efficiency supports many companies in the healthcare technology space as well as select biopharmaceutical companies.
Industrials have underperformed lately, but dispersion has been high and there are plenty of high-quality companies with premium returns on equity (ROE), attractive valuations, and opportunities to benefit from a structural pickup in capital expenditures.
Selectivity in emerging markets. Emerging markets are in a tough place given the strong dollar and the impact of rising rates. China further adds to the pressure at the index level. But look beneath the surface and there are some interesting opportunities, Orton said. He has long favored India, and he said the region continues to hold up quite well with broad market participation. Positioning is light from a global investor perspective and India benefits from some of the key megatrends like supply chain diversification as multinationals rethink their global footprint. Massive infrastructure spending to support this coupled with a burgeoning consumer class also provides long-term growth tailwinds.
Lean into value in Japan. Japan has benefitted from the higher for longer interest rate policy as it helps the country complete its exit from deflation. Rising asset flows and inflation provide support to growth and investments while structural changes help increase shareholder-friendly actions and better capital allocation. Despite a strong rally year to date, valuations are still reasonable and sit around their long-term median. Orton said he favors leaning into value sectors given their leverage to rising rates and prefers to take underweight positions in defensive Japanese stocks.
“It’s also worth pointing out that we’re likely to see some relief at the front end of the curve as the market comes to accept that the Fed is done with its rate hiking cycle,” Orton said.
Last week, U.S. Federal Reserve Chair Jerome Powell stuck to the central bank’s party line, noting that financial conditions “have tightened significantly in recent months.” Furthermore, Powell said he is looking for “additional” evidence of persistently abovetrend growth beyond just the resilience seen in the third quarter or a reversal of the loosening trend in the labor market as factors that “could” warrant further tightening. Similarly, Fed Governor Christopher Waller said his threshold to hike again is persistently strong growth and progress on stalling inflation.
“My reading of recent fedspeak, coupled with my analysis of financial conditions, supports the expectation for no further rate increases at upcoming policy meetings,” Orton said.
Earnings — Will a huge week of earnings reports be enough to bring the focus back to company-specific fundamentals rather than macroeconomic and geopolitical uncertainty? Along with some tech mega-caps, reports are coming from key companies in consumer goods, oil and gas, and pharmaceuticals.
The Fed — Expect the endless speculation around potential rate hikes or cuts to drag on, Orton said, even though Federal Open Market Committee members are in a blackout period ahead of their next meeting in November.
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.
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%.
Bear steepening refers to a move when interest rates move higher, but are led by longer-term rates that shift the entire curve higher.
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.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
Emerging markets describe economies of developing nations that are becoming more engaged with global markets as they grow. Emerging market economies generally have some but not all of the characteristics of a developed market, which include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.
An exchange-traded fund (ETF) is a type of security that tracks a market index, sector, commodity, or other assets, but which can be bought or sold on a stock exchange the same way a regular stock or other security can. An ETF can be structured to track a wide variety of securities, including stocks, bonds, individual commodities, diverse aggregations of securities, and
specific investment strategies.
The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.
Fedspeak is a slang term used in finance to describe comments from U.S. Federal Reserve officials on the economy and the possibility of changes in monetary policy.
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.
The iShares 20+ Year Treasury Bond ETF (TLT) tracks the ICE U.S. Treasury 20+ Year Bond Index, also known as the underlying index, comprised of U.S. Treasury bonds with remaining maturities of more than 20 years.
Market of stocks refers to the diversity of technical or other characteristics that may exist at any given time within the overall stock market. For example, the stock market as a whole may rise or fall on the fortunes of a small number of very large and thus very influential stocks. But within the broader market of stocks, there can be many companies with performance, risk, or opportunities that vary significantly from what market participants may find at the index level.
The median represents the mid-point of within a range of data points.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
The ICE BofA 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.
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.
Quantitative tightening, also known as quantitative tapering, refers to the attempt by central bankers to reverse the effects of quantitative easing (QE), which is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. In quantitative easing, buying securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet. In quantitative tightening, reducing those purchases is a policy primarily aimed at interest rates and at influencing investor perceptions of the future direction of interest rates.
A real interest rate, or yield, 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.
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.
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.
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.
Standard deviation is a measure of the dispersal or uncertainty in a random variable. For example, if a financial variable is highly volatile, it has a high standard deviation. Standard deviation is frequently used as a measure of the volatility of a random financial variable.
A tactical asset allocation model is an approach to investment portfolio management that entails shifting asset allocations within a portfolio in response to risks and opportunities presented by macroeconomic conditions, market trends, or other events.
Underweight describes a portfolio position in an industry sector or some other category that is less than the corresponding weight level in a benchmark portfolio.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
The Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.
A volatility point is a unit of measure representing 0.01% of annualized standard deviation. Bid/ask spreads for over-the-counter options often are expressed in volatility points, which are also known as vol points.
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.
Indices:
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The 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.
The Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 96% of the total market capitalization of all U.S. incorporated equity securities.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-445936 Exp. 2/23/2024
Macroeconomic weakness fueled by uncertainty on a range of fronts makes selective investing more important than ever.
Watch for key secular growth megatrends — such as artificial intelligence, reshoring, and the energy transition — to guide a rebound in earnings
With the broader market of stocks, there are many companies that trade at favorable valuations where earnings could provide a catalyst to the upside.
Macroeconomic uncertainty hasn’t gone away and probably won’t anytime soon.
That said, Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, advocates for this being a time for investors to search for particular kinds of opportunities within a muddled bigger picture.
“I believe opportunity in the market really exists more at the stock and the industry level as opposed to the broader market,” he said. “It’s a good time to be picking idiosyncratic risk in the market, and my main theme is the notion of quality, which means companies that don’t just have positive earnings, but are growing their earnings. For those investors who are willing to lean into some of this uncertainty, it’s a good opportunity to find things in the market to set yourself up for success over the longer term.”
Broadly, geopolitical tensions are ratcheting up, inflation continues to confound investors, and economic data provides ammunition for both bulls and bears. After a strong September non-farm payrolls report earlier in the month, the U.S. Federal Reserve (Fed) got little relief from last week’s Consumer Price Index (CPI). Instead, non-housing services inflation — the category most important to the Fed — accelerated sequentially, with both revenge and non-revenge spending line items driving the category higher. Add to that a failed 30-year Treasury auction — with weak demand from investors forcing dealers to buy nearly twice the average amount of untaken bonds — plus continued dysfunction in Washington, and it makes sense why the market can’t seem to find its footing.
“It’s no surprise that consumers and investors alike are feeling pretty down right now, but I would argue that things aren’t so bad, especially as you start looking beneath the surface,” Orton said. The S&P 500 Index is down only 5.7% from its peak on July 31 while financial conditions have tightened meaningfully with the real interest rate on the 10-year U.S. Treasury note up 70 basis points over that same period. However, the broader market is in much worse shape with the S&P 500® Equal Weight Index down nearly 10% from its peak and the Russell 2000® Index down nearly 15%. That said, earnings season just kicked off, and results so far have been strong. Big banks delivered generally positive results and commentary that the consumer was just fine, while strong results from a major health insurance company are a reminder of the value in beaten-down sectors like healthcare. With the broader market of stocks trading at 16.3x corporate earnings, there are many companies that trade at favorable valuations where earnings could provide a catalyst to the upside.
“The key is to lean into quality – profitability, earnings growth, free cash flow, lower leverage – across all investments going forward,” Orton said. “The weakness due to macro uncertainty has created a number of opportunities, and selectivity matters more than ever.”
The inflation data last week injected even more uncertainty into the market and serves as a reminder of the normalization process that has been occurring as the market adjusts to the notion of interest rates staying higher for longer. Considering that the core CPI report included some worrying signs around non-housing services inflation and a jump in both short- and long-term inflation expectations, Orton said it’s the result of the synchronous chorus of recent Fed speakers re-focusing on financial conditions, and in particular, on the notion that there is less urgency to raise short-term rates against a backdrop of rising longer-term rates.
CPI was a mixed bag
Disinflationary trend remains intact, but there are some worrying signs
Source: Bloomberg, as of 10/13/22
Failed auction keeps pressure on back end of curve
Highest yield in a U.S. Treasury 30-year auction since 2007
Source: Bloomberg, as of 10/13/22
“Ultimately, the data last week doesn’t change a whole lot about my understanding of the economy or how the Fed is likely to manage policy strategy moving forward,” Orton said. “If anything, I believe there are asymmetric risks for additional steepening of the yield curve.”
Stronger economic data would likely be reflected in the back end of the curve, he said. Weaker economic data, on the other hand, would be likely to increase the probability of rate cuts at the front end while the back would continue to reflect the current preference of the Fed to keep rates in restrictive territory. Earnings from retail sales this week could show whether this idea holds water and will provide the first test for any signs of cracks appearing in U.S. consumer spending as student loan repayments will start to be a factor.
“So, how should we think about investing in this environment?” Orton asked. “While the macroeconomic conditions are understandably discomforting, we cannot be handicapped by this uncertainty.”
Rather, he said investors should focus on identifying positive and durable trends at the stock or industry level. Earnings season provides an opportunity to lean into the volatility and the significant underperformance of the broader market of stocks. Orton is encouraged by bank earnings so far as a reflection of the actual state of the economy and said they set a positive tone for earnings season, which he expects to mark the start of a broader earnings recovery. A focus on quality should permeate portfolio construction right now, he said, and investors should avoid macro plays and instead lean into some of the key secular growth megatrends that he expects to guide the rebound in earnings. These include the buildout and integration of artificial intelligence (AI), reshoring, the energy transition, and an aging population. Here are several areas of potential opportunity he’s thinking about:
Rotating into energy, industrials and healthcare. Orton has favored energy for the past few months and still likes the sector. Valuations remain attractive, earnings should accelerate after this quarter with oil prices resetting higher and as we move past the most difficult comparisons to last year, and the sector is positively correlated to real interest rates. Energy has also underperformed its beta to rising oil prices and analysts’ expectations actually have been moving higher heading into earnings releases.
Within healthcare, earnings have started on a positive note and valuations broadly have come down while earnings are largely underappreciated. The impact of an aging population and the need for increased efficiency supports many companies in the healthcare technology space as well as select biopharmaceutical companies.
Industrials have underperformed lately, but dispersion has been high and there are plenty of high-quality companies with a premium return on equity and attractive valuations that will benefit from a structural pickup in capital expenditures.
Tactical asset allocation. Traditional static asset allocation models that assume a low-rate world do not work anymore. ZIRP — zero interest rate policy — is gone and we’re in a world with higher real rates that are going to persist over the longer term. Accordingly, Orton said, investors need to be tactical, especially as volatility has increased and correlations are shifting. This tactical approach is even more important given the $1 trillion that has been added to money market funds and will eventually need to be redeployed into the market.
Rotating out of homebuilders, airlines, and retailers. These sectors were big winners earlier this year and Orton continues to favor rotating away as the recent weakness is likely to continue. Mortgage rates remain at the highest level in decades, which has naturally weighed on new home sales. Higher oil prices are feeding through to the bottom line for airlines and early earnings releases weren’t as compelling as they had been previously. He also worries that a resumption in student loan repayments, coupled with travel likely remaining flat (though at elevated levels), could weigh on growth projections. He expects similar issues with respect to the consumer and changing consumption habits to create bifurcated winners and losers in retail, with the broad sector to continue to be under pressure.
Select Emerging Markets and Japan. Orton has long favored India, and the region continues to hold up quite well with broad market participation. Positioning is light from a global investor perspective and India benefits from megatrends like supply chain diversification as multinationals rethink their global footprints. Massive infrastructure spending to support this, coupled with a burgeoning consumer class, also provides long-term growth tailwinds.
Even with a rapidly rising dollar and increasing rates, pockets within emerging markets like Asia ex-China also have outperformed.
Within developed markets, Japan can continue to build on its breakout. Having lifted all pandemic restrictions only early this year, Japan’s modestly paced economic recovery looks set to continue. The main drivers of pent-up demand and inbound tourism should be helped by terms of trade and still-accommodative fiscal policy. It’s also worth noting that the rally in Japan is being driven by value, which stands in sharp contrast to the United States, where the rally has been all about growth.
Tuesday — U.S. retail sales will be released and are expected to show a small increase in the core rate from August. Industrial production and housing starts are also scheduled to be released and are expected to show month-over-month gains.
Thursday — Fed Chair Jerome Powell is scheduled to speak as the blackout period for Fed speakers ahead of the next Federal Open Market Committee meeting approaches.
Earnings — The financials sector will be in focus and Orton plans to pay particular attention to the results and guidance from regional banks. We’ll also hear from companies in electric vehicle manufacturing, consumer goods, pharmaceuticals, online streaming, and semiconductors.
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.
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.
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 CPI, as reflected in 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, excluding food and energy. Core CPI is widely used by economists because food and energy have very volatile prices.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
Emerging markets describe economies of developing nations that are becoming more engaged with global markets as they grow. Emerging market economies generally have some but not all of the characteristics of a developed market, which include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.
The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.
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.
Headline readings of inflation, also known as nominal inflation, include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index. By contrast, core measures of inflation exclude food and energy prices and are used as economists and other market participants as a more reliable measure of inflation trends.
Idiosyncratic risk, also known as specific risk or unsystemic risk, refers to inherent factors that can negatively impact individual securities or particular groups of assets. Depending on their characteristics, certain securities or groups will have more idiosyncratic risk than others.
Market of stocks refers to the diversity of technical or other characteristics that may exist at any given time within the overall stock market. For example, the stock market as a whole may rise or fall on the fortunes of a small number of very large and thus very influential stocks. But within the broader market of stocks, there can be many companies with performance, risk, or opportunities that vary significantly from what market participants may find at the index level.
The payroll report, known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
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. 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.
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.
Revenge spending is a term used by economists and corporate executives to describe the rise in spending on things like hotels, airline tickets, and recreation as consumers’ pent-up desire to resume traveling and socializing were released following the easing of the COVID-19 pandemic.
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.
A static asset allocation model is an approach to investment portfolio management that is characterized by identifying a target allocation for each asset class represented in the portfolio and generally sticking to the target allocations over a particular period of investment.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
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.
A zero interest rate policy (ZIRP) is when a central bank sets its target short-term interest rate at or close to 0%, typically to expand credit and stimulate economic activity.
Indices:
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes.
M-441309 Exp. 2/16/2024
Despite an extreme shift in investor positioning and surging real interest rates, the strong payrolls report suggests that the economy remains on both a solid footing and a path consistent with the Fed’s inflation target.
Elevated macro uncertainty, geopolitical strife, and recent big moves across asset classes underscore the importance of leaning into quality.
The broader market continues to lag. Could earnings season change that?
It has been a bumpy few weeks for investors across asset classes, but Friday’s price action provided a glimmer of hope that the current process of normalization might finally be taking a breather.
“The upward push in yields over the last month has felt unrelenting, and this has weighed on equities and investor sentiment,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “While the focus naturally rests upon nominal interest rates, for the most part the rise in yields — both in the United States and globally — has been a real-rate phenomenon.”
The market pushed back against the idea of “higher for longer” interest rates for most of this year, but the September Federal Open Market Committee (FOMC) meeting finally forced a change. In particular, there was hawkish shift in the U.S. Federal Reserve’s forecast of real rates from the Summary of Economic Projections. Based on policymakers’ median forecasts of the core Personal Consumption Expenditures (PCE) Price Index and federal funds rate, the real rate would rise from 1.9% at the end of 2023 to 2.5% at the end of next year.
In response, the change in investor positioning was extreme. Real 10-year rates have surged nearly 50 basis points since the September FOMC meeting. Naturally, Orton said, such a large and swift move has weighed on equity valuations and injected more uncertainty around the soft-landing narrative. The upward move in rates also has fueled an already surging U.S. dollar: another headwind for equities. Still, he said, Friday’s strong but not hot payrolls report was a reminder that the economy remains on both a solid footing and a path consistent with the Fed’s inflation target.
Real interest rates have surged higher over the last six months
Source: Bloomberg, as of 10/6/22
“But one data point and one day of price actions does not make a trend,” Orton said. This week brings both the Consumer Price Index (CPI) and the kickoff of earnings season in earnest. Increased macroeconomic and geopolitical uncertainty, along with recent big moves across asset classes, further emphasize the importance of leaning into quality — profitability, earnings growth, free cash flow, and lower leverage — across all investments going forward, he said. While the recent pullback created opportunities, he said selectivity matters more than ever.
One surprise in the recent market pullback was the continued underperformance of the broader market. The cap-weighted S&P 500 is now the strongest it’s been versus the S&P 500 Equal Weight Index since November 2020, with sectors like information technology and communication services actually outperforming since the market drawdown started on July 31. Orton sees this as perhaps a result of increased earnings enthusiasm: U.S. earnings-revision momentum rose for a second straight month in September, driven by tech and consumer discretionary, and we’ll start to get results for those companies is just a few weeks. Despite the spike in real rates, valuation concerns seem to have been offset by the perception of quality. However, he said the broader market of stocks needs to start working again for equities to move higher on a sustainable basis. The valuation compression that has taken place over the past few months now puts the broader market of stocks at 16.0x forward price to earnings, below the average and median levels over the past 15 years (17.5x and 16.8x, respectively).
“I believe the price is right for many higher-quality companies that have been forgotten about amid the macro uncertainty,” Orton said. “Perhaps earnings season will provide a much-needed catalyst to increase market breadth.”
Markets certainly seem to be at a crossroads, he said. While the S&P 500 managed to jump higher after approaching its 200-day moving average, Orton is looking for more follow-though this week. But war in Israel makes the macroeconomic environment even more treacherous, he said. Similarly, he said there needs to be additional relief on interest rates. Financial conditions have tightened meaningfully and it’s too early to know whether the pause over the past few days will last.
The S&P 500 tends to follow financial conditions
Source: Bloomberg, as of 10/6/22
Rapidly tightening financial conditions have sent the S&P 500 lower. The market’s recovery on Friday occurred as the upward move in rates subsided and financial conditions eased just a bit.
Goldman Sachs U.S. Financial Conditions Index
Source: Bloomberg, as of 10/6/22
Financial conditions have hit the highest levels since the October 2022 lows. Fed speakers signal that the recent tightening may have done some of their work for them, possibly providing some relief, especially if CPI comes in as expected this week. Fed comments this week will be important to follow to get a sense of whether the relief can last.
“I do worry about the abrupt steepening of the inverted yield curve, which hasn’t received too much attention, but it’s the type of thing you tend to see just before or during recessions,” Orton said. “That’s certainly not my base case, and the good news is that bear steepenings that leave the curve in inverted territory represent a less immediate recession threat than bull steepenings that push the curve into positive territory. Regardless, it’s yet another metric that represents a concern to investors. And it’s yet another reason to lean into quality and find opportunities that are driven more by idiosyncratic factors than by the overall macroeconomic environment.”
It will be important to follow the market reaction to geopolitics over the next few days, Orton said. In rates, he said the initial classic safe-haven response seems to be hampered by fears that a potential supply shock in commodities could revive headline inflation and limit central bankers’ ability to cut rates in a downturn. This is particularly true after the strong upside surprise in U.S. payrolls. However, he said the significant tightening in financial conditions over the last month also should help tamp down the need for any more policy rate hikes, and just how much this tightening impacts Fed officials’ views will be a key theme of their comments this week. Orton said he continues to believe the current 5.50% will be the terminal fed funds rate. Given these crosscurrents, he said he believes it’s important to leverage the drawdown to find opportunities in high-quality companies poised to benefit from durable secular growth trends that can rise above the macroeconomic uncertainty. Orton’s thoughts for near-term positioning include:
Rotating out of winners like homebuilders, airlines and retailers. Mortgage rates remain at the highest level in decades, which has naturally weighed on new home sales. Higher oil prices will likely feed through to the bottom line for airlines. Even if they do pass through costs to the consumer, Orton worries that a resumption in student loan payments, coupled with travel likely remaining flat (though at elevated levels), is already baked into prices for the major air carriers. Similar consumer-related issues also will weigh on retailers that took a hit in September.
Watching for rotation opportunities in energy, industrials and healthcare. Quality should permeate any allocation changes that are made, Orton said and there are plenty of high-quality companies in these sectors. Megatrends that he expects to dominate the secular landscape in the coming year also touch these sectors, including artificial intelligence (AI), reshoring, the energy transition, and an aging population.
Orton has and continues to favor energy. Despite the recent rally, he said valuations remain attractive, earnings should accelerate now that oil prices are rising and we’re past difficult comparisons to last year, and the sector is positively correlated to real rates.
Within healthcare, he said, valuations have come down and earnings are largely underappreciated. The impact of an aging population and the need for increased efficiency supports many companies in the healthcare technology space as well as select biopharmaceutical companies.
Industrials have underperformed lately, but dispersion has been high and there are plenty of high-quality companies with attractive valuations and returns on equity, plus opportunities to benefit from a structural pickup in capital expenditures.
Being selective in Emerging Markets (EM) and Japan. Orton has long favored India and noted that India has held up well during the broader market drawdown. Positioning is light from a global investor perspective and India benefits from key megatrends like supply chain diversification as multinationals rethink their global footprints. Massive infrastructure spending to support this coupled with a burgeoning consumer class also provides long-term growth tailwinds. Even with a rapidly rising dollar and increasing rates, pockets within EM like Asia ex-China also have outperformed.
Will interest rates continue to rise this week or will we finally get some relief?
Thursday’s CPI report will be the key economic event.
FOMC September meeting minutes could provide additional nuance to the debate on the potential for a November hike. Ten Fed officials (four governors and six regional presidents) also are scheduled to speak, with many focusing specifically on the outlook. Several have already flagged the tightening in financial conditions and its impact on their policy outlook, and Orton said he expects this to feature more prominently this week, especially given the still-hot labor demand reflected in the September payrolls report.
Earnings season unofficially kicks off with money center banks announcing results on Friday. According to FactSet, the estimated third-quarter earnings per share decline for the S&P 500 is -0.3% year over year, though Orton expects a return to growth by the end of earnings season.
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.
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%.
Bear steepening refers to a move when interest rates move higher, but are led by longer-term rates that shift the entire curve higher.
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.
Bull steepening occurs when markets price imminent interest rate cuts by the U.S. Federal Reserve, causing near-term yields to fall sharply and more quickly than long-term rates.
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 is measured by the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, also known as the core PCE price index, is a measure of the prices that U.S. consumers pay for goods and services, not including two categories – food and energy – where prices tend to swing up and down more dramatically and more often than other prices. The core PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, measures inflation trends and is watched closely by the U.S. Federal Reserve as it conducts monetary policy.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
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.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
Emerging markets describe economies of developing nations that are becoming more engaged with global markets as they grow. Emerging market economies generally have some but not all of the characteristics of a developed market, which include strong economic growth, high per capita income, liquid equity and debt markets, accessibility by foreign investors, and a dependable regulatory system.
The federal funds rate, known as the fed funds rate, is the target interest rate set by the Federal Open Market Committee of the U.S. Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.
The 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.
Forward price-to-earnings (forward P/E) is a version of the ratio of price to earnings that uses forecast earnings for the P/E calculation. The earnings used in this ratio are an estimate and therefore are not as reliable as current or historical earnings data.
The 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 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.
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.
Headline readings of inflation, also known as nominal inflation, include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index. By contrast, core measures of inflation exclude food and energy prices and are used as economists and other market participants as a more reliable measure of inflation trends.
Market of stocks refers to the diversity of technical or other characteristics that may exist at any given time within the overall stock market. For example, the stock market as a whole may rise or fall on the fortunes of a small number of very large and thus very influential stocks. But within the broader market of stocks, there can be many companies with performance, risk, or opportunities that vary significantly from what market participants may find at the index level.
Nominal values refer to the current price without taking inflation or other factors into account as opposed to real values, which include adjustments changes in general price levels over time.
The U.S. Bureau of Labor Statistics (BLS) payroll report, known as the Employment Situation Summary, is a monthly report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.
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.
A real interest rate, or yield, 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.
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.
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 summary of economic projections is produced following meetings of the Federal Open Market Committee and includes meeting participants’ projections of the most likely outcomes for real gross domestic product growth, the unemployment rate, and inflation for a forward-looking three-year window and over the longer run.
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.
Valuation compression, also referred to as multiple compression, is an effect that takes place when a company’s earnings rise, but its stock price does not move in response. This decreases the company’s financial multiple, and this often reflects a change in investor expectations. In the case of a company that posts flat earnings, a multiple compression could see the stock price fall or, in the event that the company reports falling earnings, the stock price could fall faster than the earnings.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
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.
Indices:
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
M-435821 Exp. 2/9/2024
The process of normalization continued last week, leaving most markets very oversold, said Matt Orton, CFA, Raymond James Investment Management’s Chief Market Strategist. U.S. bond yields saw their biggest quarterly jump since 2009, and the S&P 500 Index posted its first three-month loss since September 2022. The message that U.S. interest rates will remain higher for longer finally seems to be getting through to investors, and in Orton’s view the downturn in both equities and Treasuries makes sense.
The 30% surge in West Texas Intermediate (WTI) crude oil over the past quarter, coupled with the United Auto Workers (UAW) strike, is feeding into concerns that the U.S. Federal Reserve (Fed) might still be inclined to increase interest rates once more at its upcoming November meeting. While there is plenty of uncertainty for a week packed with economic data releases, Orton said there are also positive developments in which investors can take solace.
“I was encouraged by the economic data last week that showed there is continued strength in the labor market and that inflation continues to slow despite growth in real consumption,” he said. The latest results of the CFO Survey by Duke University and the Federal Reserve Banks of Richmond and Atlanta showed a modest improvement in sentiment. “That helps support the notion that we’ve likely seen the trough in earnings,” he said, adding, “We also saw information technology and small caps attract significant investor interest at the end of the week, with both the Nasdaq Composite Index and the Russell 2000® Index finishing the week in the green.”
The realized 1-month correlation between the constituents of the S&P 500 Index is hovering at 0.24, despite the broad declines in the market over the past few months. Orton believes this highlights that there are idiosyncratic opportunities in the market. “None of this means that we’re out of the woods, but it does give me confidence that it’s time to start opportunistically taking advantage of the recent downturn,” he said. He continues to suggest investors lean into quality, especially as the impact of higher real rates moves through the economy. Within the context of quality, he also believes investors can benefit from focusing on secular growth trends, like reshoring or the aging population, that cut through all the short-term macroeconomic noise.
Low correlations between stocks suggest investors are not panicked about the entire market
S&P 500 Index realized 1-month correlation
Source: Bloomberg, as of 9/29/22
Orton acknowledged that the lackluster price action over the past few days doesn’t inspire confidence that the worst is behind us, but it does at least show that buyers are willing to dip their toes back in the market. The S&P 500 Index is down 6.6% since its peak on July 31, and the Nasdaq is down only 7.1% from its peak on July 18. “These are perfectly healthy drawdowns – the first meaningful downside since early March – particularly considering that 10-year rates are up more than 60 basis points over the period, and real rates are up even more,” he said.
The dramatic increase in longer-dated real rates over a short period is just starting to work its way through the economy, and Orton does not expect it to impact all companies equally or at the same time. “This is why I believe it’s so important to lean into quality – as exhibited by strong balance sheets, profitability and free cash flows,” he said. “Companies with these strong fundamentals should be able to continue to invest in their businesses, and it’s among these companies that we should see earnings and margin strength.”
Orton also noted that, all things being equal, higher real rates imply lower equity market valuations. “We’ve seen valuations come down across some of the most expensive names during this selloff,” he said. In his view, valuations for the broad market of stocks look quite reasonable with a forward price-to-earnings ratio of 16.2x for the S&P 500 Equal Weight Index versus 19.6x for its market-capitalization-weighted counterpart, the traditional S&P 500 Index. Rate volatility has also been elevated recently, a condition that highlights the heightened macroeconomic uncertainty. “If we can see some degree of rate stabilization, that could translate into greater investor willingness to come back to the market,” he said.
Valuations for the market of stocks are below their pre-pandemic levels
Valuation metrics for the S&P 500 Equal Weight Index
Source: Bloomberg, as of 9/29/22
The potential impact of higher oil prices on the economy has become a concern for investors. WTI crude was up more than 30% in the third quarter. “It’s undeniable that higher energy prices, and the underlying reasons for them, will have important ramifications for the global macro environment,” said Orton. The jump in oil prices has been driven by production cuts from OPEC+ (The Organization of Petroleum Exporting Countries plus other oil-producing nations) and by Saudi Arabia in particular. Changes in demand – including a less bearish narrative about the impact that a slower-growing China could have on global demand for oil – are playing a significant role in the current bullish sentiment, Orton said.
The fact that part of the increase in oil prices reflects better demand, rather than purely negative supply, could help mitigate the overall economic impact of the higher oil prices, Orton said. Over time, the United States has also shifted to become a net oil producer. Orton emphasized this means that the cost of higher oil prices on consumers should be weighed against the benefits of higher prices for oil producers.
“Overall, the net impact could reinforce the notion of rates remaining higher for longer,” Orton said. Still, he added, “Right now, I don’t believe there is enough of an inflationary impact from higher oil prices to cause the Fed to re-start rate hikes.”
He pointed out that the determining factor will be whether the oil price shock has material “second-round” effects on core inflation. It could, for example, cause inflation expectations to rise and/or increase real wage growth. The shock could also bring significant indirect effects, as firms push up prices for their customers because the companies have higher input costs.
In the aftermath of the 6.6% drawdown in the S&P 500 Index over the past two months, Orton said he believes that oversold conditions have developed everywhere, and sentiment is highly negative. Only 15% of stocks are trading above their 50-day moving average, and fewer than 25% are trading above their 10-day moving average. “While this usually indicates an oversold market that is approaching the end of its decline, how the market responds this week will be important,” said Orton. As he notes, oversold conditions during bull markets tend to be shallow and generally don’t persist. “While the lack of follow-through from last Wednesday’s bounce wasn’t encouraging, I did like that the most oversold parts of the market were constructive,” he said.
How the market responds this week will be an important test, Orton emphasized. “Frankly, some cooler economic data might be welcome to arrest the upward rise in U.S. yields,” he said. Still, he believes investors could use this downturn to better position portfolios heading into the end of the year. “We’ve seen more than $1 trillion flow into money market funds this year, and any sign of ‘peak rates’ could be a catalyst for some marginal movement of that cash back into the market,” he said. Companies will also begin reporting their third-quarter earnings in a few weeks, and Orton expects the S&P 500 will return to positive earnings growth. “What you own matters more and more, and there is still an opportunity to own high-quality companies for very reasonable valuations,” he said.
Rotate out of winners like homebuilders, airlines and retailers. Mortgage rates briefly crossed 7.8% last week, the highest level since 2000. New home sales have taken a hit, and Orton said he believes the homebuilders’ earnings could struggle after having recovered earlier this year. Higher oil prices could also impact the bottom line for airlines. “Even if they do pass those higher costs to the consumer, I worry that a resumption in student loan repayments and the fact that travel will likely remain flat, albeit at elevated levels, has already been baked into prices for the major carriers,” he said. The same issues – including higher oil prices and the resumption of student loan payments – will also have an impact on consumers. Any declines in consumer spending will weigh on retailers, which already took a hit in September, Orton noted.
Rotation opportunities in energy, industrials and healthcare. The focus on quality should drive any allocation changes that
are made, and Orton believes there are plenty of high-quality
companies in these three sectors. As he noted, these sectors will
all be positively impacted by some of the megatrends – such
as artificial intelligence, reshoring, the energy transition, and
an aging population – that are likely to dominate the economic
landscape in the coming year and many years ahead. “I have
favored energy for the past few months, and I still believe the
sector looks attractive,” he said. “Despite the recent rally in their
stock prices, valuations remain attractive, and earnings should
accelerate now that we’re past difficult comps,” when the energy
companies’ earnings were being compared to past periods. The
sector will also benefit from oil prices resetting higher and the
fact that energy companies’ earnings are positively correlated to
real rates.
Within healthcare, valuations have come down, and these
companies’ earnings have been largely underappreciated by
the market. The impact of an aging population and the need for increased efficiency supports the long-term prospects for many
companies in the healthcare technology space as well as select
biopharmaceutical companies. Industrials have underperformed
lately, but the dispersion of their returns has been high. Orton
believes there are a number of high-quality companies with
a premium return on equity and attractive valuations that
will benefit from the increases in capital expenditures across
industries.
Selectivity in emerging markets and Japan. Orton, who continues to favor India, notes that the correction in India’s stock market has brought it only 3% below the all-time highs it reached just a few weeks ago. The country also stands to benefit from the move by U.S. companies to diversify their supply chains. Not all supply chains can or will be reshored back to the United States, however, and India has benefitted as corporations rethink their global footprints. Massive infrastructure spending in India to support this shift, coupled with a burgeoning consumer class in the country, could provide long-term tailwinds for growth in India’s economy. Within developed markets, Orton believes Japan can continue to gain momentum. Since Japan lifted all of its pandemic restrictions only earlier this year, the country’s modestly paced economic recovery appears ready to continue. The main drivers of its economic growth – pent-up demand and inbound tourism – should be helped by favorable terms of trade (the ratio of the price of exports to the price of imports) and a still-accommodative fiscal policy. Orton said it’s also worth noting that the rally in Japan is being driven by value stocks, which stands in sharp contrast to the United States, where the rally has been all about growth.
Investors will likely breathe a sigh of relief that a government shutdown was avoided. With government offices still at work, key economic data should be released as scheduled this week, including the September jobs report. A slew of other key reports are also due to be issued, including the Institute of Supply Management Purchasing Managers Index (PMI), the Job Openings and Labor Turnover Survey, and vehicle sales. The week will also deliver forums for comments from members of the Fed, including a roundtable discussion about efforts to grow the economy that Fed Chair Jerome Powell and Federal Reserve Bank of Philadelphia President Patrick Harker held with employers and small business owners.
The September Consumer Price Index report will be released Oct. 12. Orton suggested also investors pay attention to this week’s OPEC+ meeting and the ongoing UAW strike, both of which could weigh further on investor sentiment.
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.
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%.
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 CFO Survey offers insights from business leaders on the financial outlook for their firms, the challenges they face, and their expectations for the economy. The CFO
Survey panel includes firms that range from small operations to Fortune 500 companies across all major industries. Respondents include chief financial officers, owneroperators,
vice presidents and directors of finance, accountants, controllers, treasurers, and others with financial decision-making roles. The CFO Survey is one of the
most comprehensive and longest‐running surveys of financial decision-makers. Started in 1996 by Duke University’s Fuqua School of Business, the quarterly survey is
now conducted in partnership with the Federal Reserve Banks of Richmond and Atlanta.
The term comps, short for comparables, carries different meanings, depending on the industry and context, but generally it entails a comparison of financial metrics –
often for two different time periods – or other factors to quantify performance or determine a stock’s valuation.
The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on
prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices
are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.
Core inflation is measured by the Personal Consumption Expenditures (PCE) Price Index, known as the core PCE price index. The index is a measure of the prices that
U.S. consumers pay for goods and services, excluding food and energy whose prices tend to swing up and down more dramatically and more often than other prices.
The core PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, measures inflation trends and is watched closely by
the U.S. Federal Reserve as it conducts monetary policy.
A market correction is considered to be a decline of 10% or more from previously observed highs.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on the historical volatility of
returns.
The 50-day moving average (also referred to as “50 DMA”) is a popular technical indicator used by investors to analyze price trends. It is a security’s average closing price
over the previous 50 days. The “10 DMA” is the security’s average closing price over the previous 10 days.
Fiscal policy refers to the use of government spending and tax policies to influence macroeconomic conditions, such as the aggregate demand for goods and services,
employment, inflation and economic growth. During a recession, the government may lower tax rates or increase spending to encourage demand and spur economic
activity. Conversely, to combat inflation, it may raise rates or cut spending to cool down the economy.
Growth investing is a stock-buying strategy that focuses on companies expected to increase their earnings at an above-average rate compared to their industry or the
overall market.
The Job Openings and Labor Turnover Survey (JOLTS) produces monthly data on job openings, hires, and separations, and is compiled by the U.S. Bureau of Labor
Statistics.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock. It is calculated by multiplying a company’s
current stock price by its total number of outstanding shares.
The market of stocks is a term market participants use when referring to the diversity of technical or other characteristics that may exist at any given time within the
overall stock market. For example, the stock market as a whole may rise or fall on the fortunes of a small number of very large and thus very influential stocks. But within the broader market of stocks, there can be many companies with performance, risk, or opportunities that vary significantly from what market participants may
find at the index level.
The Organization of the Petroleum Exporting Countries is an organization enabling the cooperation of leading oil-producing countries to collectively influence the
global oil market and maximize profit. Current OPEC members are Algeria, Angola, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, the Republic of the
Congo, Saudi Arabia, the United Arab Emirates and Venezuela. Ecuador, Indonesia and Qatar are former OPEC members. A larger group called OPEC+, consisting of
the OPEC members plus other oil-producing countries, formed in late 2016 to exert more control on the global crude-oil market. Canada, Egypt, Norway and Oman
are observer states.
The price-to-earnings (P/E) ratio measures 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.
The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply
Management (ISM) and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying
the same, or contracting.
Real rates, or real rates of return, are the annual percentages of profits earned on investments, adjusted for taxes and inflation. Real returns are lower than nominal
returns, which do not subtract taxes and inflation.
Real wages are wages adjusted for inflation, or, equivalently, wages in terms of the amount of goods and services that can be bought. This term is used in contrast to
nominal wages or unadjusted wages.
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.
Secular trends are characterized by consistent gains over the long term, regardless of other market trends.
Terms of trade (TOT) is the relative price of exports in relation to the prices of imports. It can be interpreted as the amount of import goods an economy can purchase
per unit of export goods. An improvement of a nation’s terms of trade benefits that country in the sense that it can buy more imports for any given level of exports. The
terms of trade may be influenced by the exchange rate because a rise in the value of a country’s currency lowers the domestic prices of its imports but may not directly
affect the prices of the commodities it exports.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
West Texas Intermediate (WTI) is a grade or mix of crude oil. The term is also used to refer to the spot price, the futures price, or assessed price for that oil. In colloquial
usage, WTI usually refers to the WTI Crude Oil futures contract traded on the New York Mercantile Exchange (NYMEX). The WTI oil grade is also known as Texas light
sweet, oil produced from any location can be considered WTI if the oil meets the required qualifications.
Indices:
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 7% of the total market capitalization of the Russell 3000® Index.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.
M-432861 Exp. 2/2/2024
