Dollar Doldrums, Lessons from 2002–03, Bright Spots - Transcript

Welcome to RBC’s Markets in Motion podcast, recorded October 3, 2022. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers. Today in the podcast, we reflect on hot topics and some of the most interesting things we saw and heard last week. Three big things you need to know:  

Three big things you need to know: First, the stronger Dollar is a clear negative for S&P 500 performance and earnings, but US equities still tend to benefit from safe-haven status within the broader global equity landscape and certain sectors tend to be more insulated from an EPS perspective. Second, S&P 500 performance in 2022 has been similar to how stocks traded in 2002 following the Tech bubble and the initial rally off the September 2001 lows. Back then, the bottoming process was lengthy with similar lows tested multiple times before the recovery could resume, but stocks did stage a strong rebound in 4Q of 2002 off an October low. Third, US equities may not be out of the woods, but there are a few bright spots worth noting in our high-frequency indicators.

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Now, the details.

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Let’s start with takeaway #1: our thoughts on the stronger Dollar – it’s a clear negative but there are some nuances worth noting.

  • This was the topic we got the most questions at the beginning of last week.
  • We tend to see a down S&P 500 in terms of performance and weak or negative S&P 500 EPS growth and negative earnings revisions when the US Dollar is on a tear as it has been recently.

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  • But the US does still tend to outperform non-US equities when the Dollar is strengthening, and…

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  • …in terms of positioning, sectors like Financials, REITs, and Utilities tend to have far less sensitivity to the stronger Dollar in terms of earnings revisions trends.

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Moving on to takeaway #2: S&P 500 performance in 2022 has been similar to 2002.

  • We view 2022 as a year of painful normalization, the third act of the pandemic following the breakdown in 2020 and the initial recovery in late 2020 and 2021.
  • With this in mind, we compared S&P 500 in 2022 to the index’s performance in 2002–03 (a period of consolidation that followed the initial rally off the Tech bubble / recession / 9-11 lows in late 2001) and in 2010–11 (a period of consolidation that followed the initial rally off the March 2009 GFC bottom).
  • Those bottoming processes involved multiple retests of similar lows and took quite some time to play out (roughly 14 months in the case of 2002–03, and about a year and a half in the case of 2010–11).
  • Interestingly, trading in the S&P 500 in 2022 is much closer to the pattern of 2002–03 than 2010–11, with a correlation of about 72%.
  • If the S&P 500 continues to trade along the 2002–03 path in 2022, the index would rally back strongly in the fourth quarter of 2022 and then retest the lows again in the first quarter of 2023.

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Wrapping up with takeaway #3: The tone in the stock market is pretty miserable right now, but there are a few bright spots worth noting in our high-frequency indicators.

  • First, the equity put/call ratio recently spiked and isn’t too far off from December 2018 highs. Flip to slide 7
    • While retail investor sentiment and US equity futures positioning for asset managers have been highlighting extreme bearishness for a while, signs of capitulation had been missing from the put/call ratio and the VIX.

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  • Second, the P/E of the S&P 500 has gotten close to average on 2023E EPS using our below-consensus forecast of $212. As of Friday’s close, this version of the P/E was at 16.9x, compared to an average of 16.8x over time.

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  • Third, we are still seeing some stabilization in the relative performance of the most popular stocks in hedge funds, which we also saw ahead of the bottoming in the stock market in December 2018.

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  • Fourth, Republicans have taken back the lead over Democrats in the generic Congressional ballot, undoing some of the momentum that Democrats have been gaining in the polls in recent months.

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  • This last point is particularly important, as the stock market tends to bottom about a month prior to election day in mid-term years, and many investors have been looking to the event—where Republicans are thought to have the advantage—as a potential positive catalyst for stocks in the fourth quarter.

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Before we close, one last thought - Last week was highly unsettling for many US equity investors as developments in the UK stoked concerns about financial market stability. The break below the June 2022 low in the S&P 500 was also a psychological blow. We continue to see 3,500 as a pivotal test for stocks, as a move to 3,500 amounts to a 27% drawdown from the January 2022 high, in line with the median recession decline since the 1930s. If 3,500 fails to hold, we see the next big test for stocks at 3,200, when an average recession drop of 32% would be in place.

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That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for thoughts on specific sectors from RBC’s team of industry analysts.