Early Mid-Year Check In

Welcome to RBC’s Markets in Motion podcast, recorded June 4th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

This week in the podcast we’re doing a slightly early, mid-year check in on our 2021 outlook for the US equity market. Three big things you need to know:

  • First, we’re sticking with our market call and 4325 target on the S&P 500. Slipping sentiment and peaking economic and earnings indicators may contribute to a brief pullback at some point during the 2nd half, but the longer-term economic outlook remains constructive for stocks.
  • Second, we remain neutral US equities relative to non-US equities, but are admittedly feeling better about the latter.
  • Third, while we wouldn’t be surprised to see Small Cap underperform in a broader market pullback, we continue to see considerable opportunity in Small Caps longer-term and are maintaining our bias to Small over Large. We’d ride out the storm that may happen.

Slide 2

If you’d like to hear more, here’s another five minutes. While you’re waiting a quick reminder that if you find our work helpful and vote in the Institutional Investor All America Research survey, we appreciate your support in the Portfolio Strategy and Thematic Research categories.

Now, the details.

Slide 3

Takeaway #1: Slipping sentiment and peaking economic and earnings indicators may contribute to a brief pullback in the broader market at some point during the 2nd half, but the longer-term economic outlook remains constructive for stocks.

One thing really jumping out to us right now is the deterioration in sentiment underway.

  • Asset manager positioning in US equity futures has started to slip after returning to levels that came extremely close to pre-pandemic / all-time highs earlier this year. In part, this has been driven by a very slight decline in S&P 500 futures positioning.

Slide 4

  • This deterioration in institutional investor sentiment syncs up with the slippage that we’ve seen among retail investors. Net bullishness on the AAII survey has fallen sharply after returning to the troublesome 30% level earlier in 2Q.

Slide 5

  • Google searches for call options – a way to gauge the sentiment of the new generation of retail investors – have also started to fall relative to Google searches for put options.

Slide 6

While the recent loss of positive economic surprises in the US and possible peaks on S&P 500 EPS growth, manufacturing surveys, and other widely watched macro indicators may spark a loss of price momentum in the US equity market in the short term, the durability and strength of the longer-term economic outlook keeps us constructive.

Slide 7

  • 2022 real GDP forecasts among Wall Street economists are holding steady at 4%.

Slide 8

  • Historically, when real GDP comes in above 4%, S&P 500 returns average 16% in the year prior. And as we’ve discussed on the podcast before, when GDP is tracking above its long-term average of 2.5%, Value tends to outperform Growth. Overall, an economy that’s running hot longer-term, even if the rate of growth slows, should keep the reflation trade going and any pullback brief.

Slide 9

Takeaway #2:  We remain neutral US equities relative to non-US equities for 2021, but are admittedly finding that non-US equities are starting to look more interesting on a number of fronts.

  • Stronger and ramping 2021 US GDP growth relative to the rest of the world, and the modest strengthening in the USD that our FX Strategy team has been calling for, are supportive of US leadership for now.

Slide 10

  • But the US isn’t the only recovery story in play anymore and conditions are improving outside the US.
  • In terms of COVID, globally, ex US and EU, new case counts are improving, deaths have leveled out, and growth in vaccinations has become stronger. This hasn’t translated into better trends in expected 2022 GDP growth outside the US yet, but it’s something to keep an eye out on.

Slide 11

  • Additionally, the US is only in the middle of the pack on restaurant bookings per OpenTable, in terms of yr/yr improvement,

Slide 12

  • Positive economic surprises remain in Europe and Japan, even though they’ve disappeared in the US,

Slide 13

  • And manufacturing PMI’s now look stronger in Europe and Germany.

Slide 14

  • All of this has occurred against the backdrop of a number of underlying conditions that have been arguing for a rotation out of US equities into non-US equities for quite some time – US equities continue to look both over owned and overvalued.

Slide 15

  • Additionally, non-US equities tend to outperform US equities when Value outperforms Growth. If we are right on the style rotation, that argues for a bigger geographical rotation as well.

Slide 16

Wrapping up with Small Cap. While we wouldn’t be surprised to see Small Cap underperform in a broader market pullback, we continue to see considerable opportunity in Small Caps longer-term and are maintaining our bias to Small over Large.

  • Small Caps tends to underperform when ISM and inflation expectations are falling – trends that may be underway and help spark a short-term market pullback. That’s obviously not good for small caps short term.

Slide 17

  • But the key thing to remember is that the underlying economic backdrop is expected to remain strong, with real GDP well above average, through next year. Historically, when real GDP is above its long-term average of 2.5%, Small Cap tends to outperform Large Cap.

Slide 18

  • Additionally, Small Caps continue to look deeply undervalued relative to Large Caps, and money flows have been trending much better for Small Cap than Large Cap.

Slide 19

  • The fiscal spending backdrop is also supportive of Small Caps, assuming Biden is successful in getting some of his key agenda items from the American Jobs and Families plans through. Historically, Small Caps tend to to outperform Large Caps when Democrats control the White House, the Senate, and the House of Representatives.

Slide 20

  • We are not overly worried about the prospect for higher corporate taxes in regards to our Small Cap call given our work which has revealed that Large Cap Growth has been the segment of the US equity market that saw the biggest declines in corporate tax rates under Trump. It’s that part of the market that has the most to lose if Biden raises corporate taxes.

That’s all for now. Thanks for listening. Please reach out to your RBC representative with any questions.