Welcome to RBC’s Markets In Motion podcast, 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, Energy has been a top S&P 500 sector since January. We like its attractive valuations, improving funds flows, and role as an inflation hedge in our overweights. Second, Large Caps are starting to look a little better than Small Caps on a few of the earnings-related metrics that we track, suggesting to us that Small Caps’ sluggish performance of late isn’t all about Fed and inflation fears. Third, sentiment continued to slip on one of our main sentiment models from elevated levels.
If you’d like to hear more, here’s another five minutes.
Before we jump in, we wanted to share some good news. Last week, I was named by Barron’s as one of the 100 Most Influential Women in US Finance for 2024, along with my colleague Helima Croft, RBC’s Head of Global Commodity Strategy.
Now let’s jump into the details.
Starting with takeaway #1: Energy has been one of the best sectors in the S&P 500 since January.
One of the charts that caught our eye in our end-of-week updates highlights how Materials, Energy and Industrials have been the best-performing S&P 500 sectors since the end of January.
As such, we’ve been revisiting our Energy overweight in conversations. That call has been driven by our work showing that the sector’s valuations are attractive within the S&P 500, constructive views from our research analysts who cover the space relative to our teams in other sectors, and our sense that the sector is a useful inflation hedge in our portfolio.
Energy, along with Industrials and Materials, has seen a modestly positive correlation between performance (relative to the S&P 500) and trends in 10-year Treasury yields since 2010. With this in mind, it makes sense to us that these three sectors have fared well in recent weeks as inflation and interest rate fears have heated up again.
Interestingly, our funds flow data also highlights how Energy, Industrials, and Materials/Commodities dedicated funds are all seeing improving trends in funds flows in recent weeks.
Moving on to takeaway #2: Large Caps are starting to look a little better than Small Caps on a few of the earnings-related metrics that we track. While we think it’s still fair to say that Small Cap performance has stabilized relative to Large Cap, the outperformance that Small Caps enjoyed in November and December of last year and most of February has dissipated again.
In part, we think this is due to renewed fears over inflation and when/if the Fed will cut rates since cuts tend to be a trigger for Small Cap outperformance.
We don’t think this is the whole story, however. As we were running through our \ updates over the weekend, two other things caught our eye on this topic, both of which are earnings related. First, earnings sentiment (the rate of upward revisions) may be starting to shift back in the S&P 500’s favor again. In recent months, the rate of upward revisions for the S&P 500 and Russell 2000 had been close to parity.
There’s no one sector driving this, as most Russell 2000 sectors are in negative EPS revisions territory at the moment.
Within the S&P 500, most sectors are in positive EPS revisions territory or are seeing a balance between upward and downward revisions.
Second, the downgrades we’ve seen to aggregated bottom-up S&P 500 EPS forecasts have been much shallower than the ones we typically see in any given year.
Meanwhile, the downgrades we’ve seen to aggregated bottom-up S&P 600 EPS forecasts have been in line with the historical average.
Wrapping up with Takeaway #3: Sentiment continued to slip on one of our main sentiment models.
As our regular listeners are aware, we keep a close eye on the weekly AAII survey where elevated net bullishness has been signaling the potential for a short-term equity market pullback…
…and CFTC’s weekly data on US equity futures positioning. Looking at notional dollar value positioning across all US equity futures contracts for the buyside, the data has been suggesting that sentiment has been extremely elevated and close to the early-2018 and early-2020 peaks and above post-COVID peaks.
We have started to see the aggregate indicator fall in recent weeks, and that continued in last week’s update.
Declines in S&P 500 futures and Nasdaq 100 futures have both occurred.
Russell 2000 futures positioning has also slipped but has been in more of a stall than an outright decline.
While our valuation work (which forecasts a trailing P/E based on consensus views on several macro variables) still points to upside beyond our 5,150 YE 2024 S&P 500 price target forecast, our sentiment work continues to signal the potential for turbulence between now and year-end.
These conflicting crosscurrents have been of interest to the investors we’ve spoken with recently. On sentiment a few new things that have caught our eye (which support the idea of it being stretched) including the U Michigan consumer sentiment survey which shows a sharp improvement in views on interest rates and the direction of the stock market in late 2023 to levels close to past peaks.
The latest data from the Federal Reserve Flows of Funds also indicates that equity allocations are getting close to past highs again as a percentage of financial assets for US households.
On the valuation side, we’ve refined a stress test we’ve been using to account for inflation and interest rates that make no improvement between now and year-end. That stress test suggests 5,000 may be a more appropriate level for the S&P 500 to end 2024 on, if our EPS forecast of $234 proves correct. The stress test also points to 5,200 as a potential year-end level if the consensus forecast of $244 is accurate. Either way, it suggests to us that recent highs are a natural place for the stock market to stall, at least temporarily, given renewed fears over inflation and the path of Fed policy.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.