Welcome to RBC’s Markets in Motion podcast, recorded November 18th, 2024. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers. Three big things you need to know: First, over the past week we’ve become increasingly convinced that a 5-10% pullback in the S&P 500 may have already started. Second, post-election company commentary has been heavily weighted to tariffs, a part of the Trump agenda that has concerned many equity investors. Third, other things that jump out from our high frequency indicators include Financials valuations that remain slightly attractive vs. the broader market.
If you’d like to hear more, here’s another five minutes.
Starting with Takeaway #1: over the past week we’ve become increasingly convinced that a 5-10% pullback in the S&P 500 may have already started.
- We pointed out last week that valuations on our forward P/E models for the S&P 500 and Russell 2000 had some room to run, but not a ton…
- …And that positioning has been looking stretched on the weekly CFTC data for US equities futures positioning – a problem that got worse last week
- This all comes after seeing AAII net bullishness goo up to more than one standard deviation above its long-term average several times in early October, a signal of an overbought market that has preceded all of the 5-10% drawdowns in the S&P 500 since late 2022.
- While animal spirits seemed strong a week ago, we noted that given where valuations and positioning were, and where sentiment had been recently, the US equity market seemed to have little capacity to absorb bad news like the dialing down of Fed expectations that’s been underway.
- Investors we spoke with late last week sounded cautious, and our conversations suggest that the move up in 10-year Treasury yields (and the related inflation and deficit concerns) is one of the main things spooking them.
- One thing we’ve been highlighting on this topic is that the earnings yield gap for the S&P 500 has suddenly turned negative and late last week stood at -0.5%. That’s still within a range that’s been accompanied by positive returns in the S&P 500 on a 6- and 12-month time frame. But if the 10-year yield moves up another 50 basis points, this model will be back in a range that is usually accompanied by a decline in the S&P 500 on both time frames.
- The stronger US dollar has also been in focus. Here, we’ve been reminding investors that when the US dollar strengthens year-over-year, the S&P 500 tends to experience downward EPS estimate revisions driven the by Industrials, Materials, Health Care, and Consumer Staples sectors. This is something to keep an eye on as a potential source of disappointment in the next reporting season.
- For now, we don’t think a drawdown in the US equity market would exceed 10% since declines more than that tend to be associated with growth scares or recessions. GDP forecasts have been firming up for both 2024 and 2025, while US economic surprises have been positive. While that could change, it gives us comfort for now that any further downside will be limited.
- Note that a 10% drawdown would also take us to around 5,400, which is about where our trailing P/E model has told us the S&P 500 deserves to end the year at if consensus forecasts for inflation, the Fed, and 10-year yields end up being correct.
Moving on to Takeaway #2, post-election company commentary has been heavily weighted to tariffs, a part of the Trump agenda that has concerned many equity investors.
- We relied on transcript analysis heavily in 2017 and 2018 as we navigated several twists and turns in tax reform and the China trade war.
- And so last week we read through all of the comments from S&P 1500 companies since Election Day in conference transcripts, and earnings calls that highlighted their thoughts on what the new administration means for their companies and industries.
- Many companies referred to the idea that it’s still early days in the new administration and too soon to know too much. In terms of specific issues, tariffs were most in focus, by a mile.
- Companies emphasized how they managed through the China tariffs, and sought to reassure investors by talking about how they have diversified their supply chain.
- This very much resonates with me – we’ve seen companies manage through one crisis after another since 2018 very successfully – but two things in the commentary did concern me: (1) the focus on China – there was very little discussion of what would happen with broad-based tariffs which is what Trump has been talking about doing in addition to bigger China tariffs this time around, and (2) companies highlighted how they passed on tariffs on through via pricing in the past – which in my mind gives legitimacy to concerns that inflation risks are rising.
- In terms of the more stock market friendly parts of Trump’s agenda, these did come up but not to the same extent as tariffs. We found a decent amount of positive commentary on M&A, deregulation and anti-trust – but not much other than expressing general optimism on these matters.
- Additionally, we found very little commentary on the potential for corporate tax cuts or tax in general, another one of the more important stock market friendly pillars of Trump’s campaign platform.
Wrapping up with Takeaway #3: a very quick thought on Financials.
- Financials remains one of the top-performing post-election sectors in both the S&P 500 and Russell 2000.
- We’re keeping a close eye on the sector, but for the moment continue to see slightly attractive valuations relative to the broader market indices within both the S&P 500 and Russell 2000.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.