April 27, 2021

Is this as good as it gets?
Post-COVID market outlook

Guest: Brian Lee, Senior Vice President and Head of Intermediary Sales

In this episode of Markets in Focus

With analysts predicting perfection and unprecedented stimulus fueling new market highs, where do we go from here? Matt Orton, CFA, Director and Portfolio Specialist with Carillon Tower Advisers, breaks down the possibilities and addresses investor concerns with Brian Lee, CFA, Senior Vice President and Head of Intermediary Sales.

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Matt Orton:
With US equities continuing to make all-time highs, it's hard to believe that it's been just over a year since the swiftest market crash on record. Unprecedented monetary and fiscal policy came to the rescue last March and the wave of trouble from the COVID pandemic seems to have left just as quickly as it came. We now also have a rapid vaccine deployment that's enabling people to get out, or at least start planning for travel in the near future. Rates are rising, market leadership has changed, and many investors are now asking, "Where do we go here?"

This is Markets in Focus from Carillon Tower Advisors. I'm your host, Matt Orton. Join me and my colleagues as we discuss the latest trends and developments driving the markets. Visit us at Marketsinfocuspodcast.com for additional episodes insights.

I'm joined by Brian Lee, Senior Vice President and Head of Intermediary sales at Carillon Tower Advisors who hears nearly every day exactly what clients are thinking and worrying about right now. And we're going to change things up just a little bit today, this time around, I'm going to let Brian take over the hosting duties and I'll be sitting in the host seat to answer his questions. So with that, are you ready to kick things off, Brian?

Brian Lee:
I am. And thank you, Matt, for being willing to share your thoughts on the market with our followers today. As you just mentioned, markets continue to make new record highs. And one of the key concerns I hear from clients and financial advisors right now is whether things are as good as they can be. Or put another way, perfection seems to already be baked into the market. I'd love to hear your thoughts about how further gains might get catalyzed.

Matt Orton:
Yeah, that's an interesting point, Brian and one that's definitely worth digging into. I've been getting similar questions from clients about how we can continue to make new highs in what I really think is going to be important going forward: earnings. Earnings are going to be absolutely critical. We've had a combination of incredible monetary stimulus, a synchronized global economic recovery, and lower interest costs. And that has allowed corporations to weather the storm pretty well. And coupled with massive fiscal stimulus, it's allowed earnings to rebound, I would say sooner and sharper than I think we were initially expecting. We're coming into the first quarter of 2021 earnings now. And I believe the expected EPS growth coming into the quarter is 23.8% EPS growth year over year. And what's particularly interesting is that the recent trend of analysts increasing expectations heading into the quarter is continuing.

We've had the past three quarters, so Q2'20 through Q4'20, where the actual S&P 500 earnings reported have exceeded estimates by 19% on average. If we get anywhere close to this type of beat, we're going to be looking at EPS growth of nearly 30% for the first quarter. And that would mark the strongest EPS growth in nearly a decade. And that I think is not fully appreciated by the market and it definitely can provide an important catalyst going forward.

Brian Lee:
That's an interesting point, Matt, about the dynamic of earnings expectations increasing throughout the quarter, are there any particular parts of the market where it's most pronounced?

Matt Orton:
Well, not surprisingly, you're seeing expectations increase in the most cyclical areas of the market that are tied to the strong economic recovery that we're going through right now. I think energy in particular sets up nicely for earnings beats. Given that year over year comps and higher energy prices in Q1 are going to provide those tailwinds, but information technology and healthcare also are setting up nicely. And we've had a really good track record of earnings beats and positive earnings growth throughout a lot of this pandemic. And I think because these sectors also have the largest upside difference between consensus bottom up price targets and current market levels, there can definitely be some additional gains to be had going forward. And I think it's this dynamic, then, where you've got strong growth in cyclical sectors and also the potential for continued strong growth in the more secular growth areas of the market that you're starting to get these really sharp rotations between growth and value as investors are trying to position themselves going forward.

Brian Lee:
So let's dig deeper into the push pull between growth and value that you alluded to, Matt. Growth stocks have been leading the market higher for the better part of the last decade and posted meaningful outperformance last year relative to value, but value stocks have been on a tear since November. Do you think it's time for these value companies to take a breather? Also, I'm curious how you're looking at growth investing right now.

Matt Orton:
Yeah, that's another important question, Brian that I think we've heard a lot from our clients about. And growth has definitely been the big winner over the last decade and especially over the last year, but the outperformance of value since early November, when we got a rush of positive vaccine data has also been pretty staggering. Value has benefited. I would say the most from the rise of interest rates that we've seen recently and the steepening of the yield curve. And that makes sense, given that financials are such a large weight within these indices, but the rally was incredibly fast and the Russell 1000 Value was recently trading at its widest spread to its 200 day moving average since I believe October, 2009. And that was just about six months after one of the deepest bear markets in the last 100 years. So I would say reset of sentiment is probably in order.

And I think that's what we're starting to see play out with this, these sharp rotations that we were discussing earlier. That said, I have been emphasizing to our clients that growth and value really shouldn't be thought of in isolation. They are non-fungible, which means they both provide unique exposures and they cannot be replaced for one another. And so that's a long way of saying you really need to have exposure to both. For the past eight months, I have been advocating about leaning into cyclicality, not just thinking about it as growth versus value, but really being levered to economic improvement, however you're allocated. And I certainly think you're going to see that play out in value, but leaning into cyclicality and growth has also been a winning play. And I'd also remind our listeners that certainly I think the enthusiasm for the economy is not misplaced. I think that's going to be here to stay, but we can't forget about secular growth either. I would say secular growth and many of those themes that have driven performance over the past handful of years is here to stay.

Brian Lee:
That's a great point regarding cyclicality, which can be found within both the growth and value portions of the market. Let me play devil's advocate for a moment and say what happens, or ask you what happens to growth either fundamentally or behaviorally if we see another spike in interest rates? And even more broadly, what are the implications for the broader equity market if rates spike again?

Matt Orton:
That's definitely an important question that we need to consider. And what I would say first is that the market seems to be most concerned with the rate of change. We really started to see a little bit of discomfort in the market when interest rates were moving very, very quickly in a short period of time. From the lows in the 10 year that we had last August, up to the end of the year, the 10 year was up a little north of 80%. And from the start of the year to now, the 10 year is up about another 80%. But what's important there is that this most recent jump happened in a much more meaningfully shorter period of time. And we also hit some psychological levels. So when you alluded to behaviorally, I think that's really important because the psychological levels on the second wave up are really important. Breaking through 1%, breaking through 1.5%, Getting to 1.75%.

Those numbers become a lot scarier to the market than going from less than 50 basis points to call it 80 basis points. So that psychological element, I think also helped to then fuel the further rate higher. And over this period of time, growth has definitely underperformed as rates have been going up. And I would say really the highest priced growth names in particular like software have been the bigger under-performers. No question, rates are going to be a headwind going forward because I do believe rates are going to continue to move higher. But it's that rate of change, I think that matters going forward. And what's really nice to see is that we're starting to see quality growth come back into favor. I would ask our listeners to look back to a period like 2018, for example, which was another period when you had interest rates starting to go up.

We started the year in 2018, I think the 10 year was around 2.4% and rates move to about 3.2% by the end of the third quarter. The Russell 1000 Growth was up 17%, and the Russell 1000 Value was up just under 4%. So yes, growth can perform well when interest rates are going up, but it's that rate of change again, that I think that matters the most. And now you have to consider that the economy is actually going to be posting some really solid gains, so value can work as well. And that goes back to that non fungibility, why it's really important to own both, but be leaned into that sort of cyclicality.

Brian Lee:
Thanks, Matt. Let's shift gears for a second and talk a little bit about international equities. It goes without saying it's been easy to outperform if you've had a domestically focused portfolio, but we did see some outperformance from Asian markets last year, and European equities have been holding up well thus far in 2021. So let's start with Europe. Can you make a case for European equities?

Matt Orton:
I knew we wouldn't be able to get through a discussion without touching on the word international, which has been a pretty bad word, I'd say, for a lot of advisors over the past number of years. But if you look at where we are today in the equity markets, international markets are actually posting some really good numbers. The S&P 500 is up just under 10%, but the Euro Stoxx 50 is up about 12%. And the Nikkei is somewhere in between since the start of the year. So it's interesting to see Europe holding up really well in spite of some really bad data and a spike in COVID cases, increased lockdowns. So that is important. I would also note that year to date European equities haven't registered any meaningful net fund flows. And that's in a year where year to date tally for equities overall are up almost $400 billion.

So European equities are still putting in solid performance, despite what I would say is still a complete lack of positioning. And I think that is what can benefit European equities going forward, because it's only a matter of time before vaccinations are going to pick up. And I would expect to see an easing of COVID restrictions during the summer, which would support a further economic rebound. Europe and international developed equities broadly are also more heavily levered to value sectors. So financials, to energy and materials, European banks have been outperforming because you have been seeing a little bit of steepening in their yield curves. Rates are going up in Europe as well. And European equities tend to outperform when banks are doing well. So I think when you couple all of that together, a lack of positive sentiment, the potential for improving fundamentals and economic growth. I think that sets up the best picture we've seen for European equities in a number of years. And it's definitely something to be watching going forward.

Brian Lee:
What about Asia or the emerging markets? I'd love to get your thoughts on those as well.

Matt Orton:
Yeah, the setup in Asia is also interesting, and particularly in Japan, the Bank of Japan has been modernizing its ETF purchases. The Nikkei is trading at a near decade high in terms of price to earnings multiples. And I think investors are becoming more selective on high valuation stocks as rates rise. Sounds pretty familiar to the U.S. right now, but Japanese exporters that have low valuations can and are starting to do well. And that should certainly continue if investors expect increasing inflation expectations in the U.S. driven by stronger demand. Emerging markets in Asia also have a higher exposure to value and cyclical sectors like banks, insurance, semiconductors, retailing, and they have lower exposure to highly valued sectors like software and healthcare. So all of that I think sets up well in a sort of economic recovery environment, which makes it very interesting. Again it's another pocket of potential relative value as we go forward to play the sort of cyclicality theme that we've been talking about.

Brian Lee:
And then I would say Matt, to wrap things up here and tie it all together, obviously the last year has been unprecedented. Some would say maybe even crazy. I would love to hear your thoughts about the biggest lessons we should all take from this. And then finally, how can we leverage those thoughts or that introspection going forward into the second quarter and the rest of 2021?

Matt Orton:
That's a really good question. If I think about this, I would say the biggest lesson is that we have to be flexible in our approach to the markets. Having only one version of the future and fitting all of the data to fit within that lens, just isn't going to work. I think you could get away with doing that over the past couple of years, really up until COVID hit, but COVID, I think really taught everyone a lesson that sometimes everything can just be tossed out the window and you really need to reconsider and be flexible in your approach to incoming data, and how you can position yourself within the market. So to think that growth is just going to outperform again, continually, might be a little bit misplaced, but also just to draw and extrapolate that that value is now going to take over and have the same sort of outperformance that growth has over the past decade, also might be a little bit misguided.

So I think really following the data and building a narrative and not being dogmatic about our approach to the markets, I think becomes increasingly more important as we go forward. And I'd say looking forward, another important lesson to draw on is the absolute power of monetary and fiscal policy. I mean, we have had unprecedented monetary and fiscal policy come into play as a result of this COVID pandemic. And the guidance that comes from the Fed really needs to be heated. I think the Fed has ample ammo to continue what it's doing. And you can't really fight the Fed. I think we've always joked and said that in the past, but I think COVID has really taught us that it's absolutely true.

And going forward, as we think about inflation, as we think about the path of rates going forward, we really should default to what the Fed is saying and be serious about the power these policies can have going forward both to corporate and economic growth. So with that, I want to thank Brian for filling in the seat and asking some really good questions. And as usual I'd like to thank our listeners for staying with us, and until next time, take care.

Thanks for listening to Markets in Focus from Carillon Tower Advisors, please find additional episodes and market insights at marketsinfocuspodcast.com. You can also subscribe to our podcast on Apple Podcasts, Spotify, or your favorite podcast app. Until next time I'm Matt Orton.


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CTA21-0260 Exp. 4/27/2023