Welcome to RBC’s Markets in Motion podcast recorded August 7th, 2023. 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, an updated overview on our market call. Three big things you need to know:
- First, we’ve tweaked our S&P 500 EPS forecasts up modestly by $1-2 to $220 for 2023 and $229 for 2024, while leaving our YE 2023E S&P 500 price target of 4,250 unchanged. While one of our models highlights potential upside to ~4,800, and we think the gains in the index so far in 2023 have been deserved, we have become concerned that the rally in the S&P 500 is due for a pause in the months ahead.
- Second, we continue to see tactical challenges for the Growth trade, though we continue to like Growth over Value longer term.
- Third, Small Caps continue to look more appealing on our work overall than Large Caps, and we remain comfortable adding exposure there despite near-term risks to market direction broadly.
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Takeaway #1: we’ve tweaked our S&P 500 EPS forecasts up modestly by $1-2 to $220 for 2023 and $229 for 2024, while leaving our YE 2023E S&P 500 price target of 4,250 unchanged.
- On earnings, we are still in line with consensus for 2023 and below it for 2024. The latter is tracking at $245.
- On our price target, 4,250 remains the average of the six models we’ve been using.
- While one of our price target models, our earnings and valuation test, highlights potential upside to ~4,800, and we think the gains in the index so far in 2023 have been deserved, we have become concerned that the rally in the S&P 500 is due to pause in the months ahead for two main reasons.
- First, three of our target models are deteriorating.
- That includes both of our cross asset models which examine the appeal of stocks vs. bonds. This is important b/c these were improving in May when we upped our target from 4,100 to 4,250.
- Our sentiment model is also eroding. AAII net bullishness was sending a strong buy signal to start the year and post SVB, but came in last week 1 st dev above its LT average. The S&P 500 only sees 5% gains on average 12 months after hitting this level.
- First, three of our target models are deteriorating.
- The second big concern is seasonality. Over the last 5 years, the stock market has tended to hit a rough patch in August or September and sometimes October.
- We may ultimately need to pull our 2023 target up a bit, but now is not the right time to do it. We view our price target as an assessment of not just where the index will be at year in, as a signaling mechanism for how we feel about the stock market. And as we’ve been saying for the past month or so, things are a bit murkier.
Moving on to Takeaway #2: we continue to see tactical challenges for the Growth trade, though we continue to like Growth over Value longer term.
- Tactical challenges we see for Growth include:
- First, Growth hasn’t been quite as dominant from an earnings sentiment perspective – the rate of upward revisions still favors Growth over Value but the gap is closing.
- Second, Growth positioning continues to look stretched – we see this pretty clearly on the weekly CFTC data for asset manager positioning in Nasdaq 100 futures.
- Third, Growth still looks extremely expensive relative to Value – there’s been some improvement but Growth is still close to the highs of the past few years vs. Value on a relative forward P/E. And…
- Growth inflows have turned to outflows, while the outflows from Value are stabilizing.
- Longer-term, Growth should bounce back given the expectation that economic growth will stay below 2% over the next few years. Growth stocks typically outperform when GDP is running below trend. But for now there are tactical challenges to work through.
Wrapping up with Takeaway #3: Small Caps continue to look more appealing on our work overall than Large Caps, and we remain comfortable adding exposure there despite near-term risks to market direction broadly.
- Our reasons for liking Small Caps include:
- First, balance sheet fears seem overblown. Just like Large Cap Companies, Small Caps have shifted towards long-term debt, have low interest expense relative to sales, and are still around historical lows on their effective interest rate. Just 9% of companies have weighted average debt in the 0-2 year range as well.
- Second, Fed cuts are expected to come in 2024 – that’s usually a positive catalyst for Small Caps.
- Third, Large Caps’ advantage on earnings sentiment is eroding. Small Caps have started to close the gap with Large Caps on the rate of upward revisions which had been favoring Large Caps.
- Fourth, Investor reengagement with Small Cap still seems early innings – CFTC data on asset manager positioning for R2000 contracts is still well below its 2018, 2019-2020, and early 2021 peaks.
- Fifth, Small Caps still look attractively valued, especially in regards to Large Caps.
- Sixth, Small Cap flows are improving while Large Cap flows are softening. Small Cap blend and value funds in particular are showing improvement.
- All that being said, we are mindful that Small Caps tend to underperform when GDP growth is below trend as is expected to be the case for the next few years. The prospect of a sluggish economic recovery may ultimately cut any Small Cap outperformance trade short. That will keep us vigilant for the appropriate time to exit our Small Cap overweight but doesn’t reduce our appetite to participate in its catch-up trade.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.