Catching Up Podcast Transcript

Welcome to RBC’s Markets in Motion podcast, recorded November 15th, 2021. I’m Lori Calvasina, head of US equity strategy at RBC. Please listen to the end of this podcast for important disclaimers.

Last week we updated our equity market outlook for 2022. Three big things you need to know:

First, we moved our 2022 target up by 3% to 5050. Second, we see inflation as supportive of US equity market positioning. Third, we reiterate our view that both Small Caps and Value are likely to see another burst of outperformance between now and mid-2022.

If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify, and other major podcast providers. Now, the details.

Takeaway #1 – last week we moved our 2022 S&P 500 target up by ~3% to 5050 from 4900.

  • We first introduced our 2022 forecast for the S&P 500 in September at 4900. Last Thursday, we adjusted that number to account for the bigger than expected move we’ve seen in the index as 2021 starts to wind down, and the latest updates in our models.
  • 5,050 is roughly the average of all of the scenarios and backtests that we examined in our process. Our economic based models were mostly a little more constructive, pointing to levels slightly above 5,100.
  • Our new target is closer to the output of our valuation based models, which evaluate stocks vs. bonds and use a target P/E multiple. These are generally less constructive than they’ve been, but are still signaling further gains in the year ahead. A case in point, our dividend yield test is calling for an 8% 12 month forward return in the S&P 500, which is the average move when 40-50% of stocks in the index have a higher dividend yield than the 10 year Treasury, as is the case today. A few months ago, that model was in a higher range that was calling for an 18% forward return in the S&P 500. 
  • Overall, our new 5,050 is calling for a 7.3% gain beyond the early November high in the S&P 500. While our target is quantitatively driven, that still sounds like the kind of story we want to tell for how 2022 is likely to unfold – a year of solid gains but more moderate returns than we’ve seen in 2021.
  • Beyond the strong economy, cash deployment trends are positive, particularly when it comes to dividends and buybacks
  • frothy earnings revisions are no longer an overhang on the market, as we’ve already seen a sharp deceleration in the rate of upward revisions, and even some stabilization again over the past couple of weeks
  • individual investor sentiment turned so bearish recently that it briefly gave a contrarian buy signal for the stock market in October,
  • and fiscal policy tilts supportive with corporate tax hikes much less of a threat that investors expected they would be for most of 2021.
  • The onset of tapering and proximity of Fed hikes have kept investors uneasy, but it’s important to remember that stocks normally post gains post lift off as long as the economy is seen as strong enough to handle it.
  • Supply chains and inflation are clearly challenges to margins, and we worry about volatility in the stock market in December and January during forecast season, but as long as conditions look likely to improve in the back half of 2022, as many investors expect, we don’t think these issues derail the year particularly since some glimmers of hope on supply chain improvement have already been seen.

Moving on to takeaway #2 - we think higher inflation is supportive of US equity positioning.

  • Historically when inflation is increasing, allocations in stocks relative to cash and bonds within US households tend to rise.
  • We think that’s important to keep in mind since one of the reasons to be bearish on US equities in the great debate over stock market direction has been the fact that US equities have looked so over owned on so many positioning studies, with equity stakes at or just below all-time highs in asset allocation funds, US households, and futures market holdings by asset managers.
  • But with inflation still running hot, it’s hard to see what will cause that equity exposure to come down near-term, which in turn makes it tough to be too bearish on US equities in the wake of last week’s higher than expected CPI print.

Wrapping up with takeaway #3 – following the breakout in performance that Small Caps have seen since late October, we reiterate our view that both Small Caps and Value are likely to see another burst of outperformance between now and mid 2022.

  • Since August, our call has been that both Small Caps and Value would see an intermediate burst of outperformance, perhaps through mid 2022, given that both have looked deeply undervalued,
  • Both tend to outperform when the economy is running above trend, as is expected to be the case again in 2022,
  • and both tend to outperform ahead of Fed rate hikes.
  • COVID was also restraining both over the summer, and when the COVID backdrop improved we saw both trades stabilize.
  • In late October, Small Caps finally started to break out with the R2000 hitting a new high and seeing strong outperformance vs. Large Cap. Value hasn’t had the same break out – we think b/c of the flatter curve and lower 10 year yields, which have been a drag on Financials,
  • as well as supply chains, which dragged down Industrials and Materials earnings revisions and performance in late summer and early Fall.
  • These rotations, and Small Cap specifically, is where a lot of our inbound call volume has been the past few weeks. We’ve been patiently waiting for rebound trades in Small Cap and Value to emerge. Besides COVID, a number of pressures have started to ease.
  • Specifically, neither Small Cap nor Value looks disadvantaged on earnings revisions trends anymore.
  • Small Caps also tends to outperform when inflation expectations are rising.
  • And Value looks much better than Growth on cash deployment trends.

That’s all for now, thanks for listening, and please reach out to your RBC representative with any questions.