Five Good Things We See In The Data Transcript

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Welcome to RBC’s Markets in Motion podcast, recorded January 31, 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.

This week in the podcast, we run through five good things we’re seeing in the data right now for the broader US equity market right now. First, bottom up 2022 and 2023 EPS forecasts have been holding steady. Second, the contraction in the S&P 500 forward P/E is in line with past Fed tightening periods.  Third, the valuation gap between the most expensive and least expensive stocks is getting close to pre-pandemic levels. Fourth, retail investor sentiment is back to pandemic lows.  Fifth and finally, Small Cap futures positioning is on the cusp of net short territory, and isn’t too far above where it bottomed in March 2020.

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Now the details.

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  • First, bottom up 2022 and 2023 EPS forecasts have been holding steady.
  • With roughly a third of S&P 500 results in for 4Q21, the full year bottom up forecast for S&P 500 EPS is still tracking at $224 for 2022 (identical to mid January’s reading), while 2023 is tracking at $247 (actually up $1 from mid January’s reading).

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  • The rate of upward revisions is also still tracking at 58% (so slightly more positive than negative revisions).

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  • Interestingly, while 52% of the S&P 500 companies that have reported so far have seen their share prices fall 1% or more in the one day trading session immediately post results, that stat is actually better than it was a week ago when it was tracking at 63%. It was helped over the past week by Tech.
  • Overall there’s been a resiliency to earnings forecasts despite the volatility in the market.

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  • Second, the contraction in the S&P 500 forward P/E is in line with past Fed tightening periods.
  • We’ve seen contraction in the broader market’s forward P/E multiple of ~16% since the end of 2021.
  • That’s important because our analysis suggests that from the high around liftoff (including those made slightly before or after the first hike) to the trough in the hiking cycle, the market’s forward P/E has experienced an average drop of 16% and a median drop of 17%. Looking back to the 90’s, the worst was 21%, the shallowest was 7%, and the last two came in at 17%).
  • Obviously the multiple contraction today could overshoot this average, and our analysis suggests that if a 21% contraction occurs (with no changes to earnings expectations), that the index could fall to ~4,150.
  • But this still tells us a lot of the damage from repricing the Fed has been done.

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  • Third, the valuation gap between the most expensive and least expensive stocks is getting close to pre-pandemic levels.
  • The ratio of the P/E multiple of the most expensive stocks relative to the P/E multiples of the cheapest stocks is now only 8% above pre pandemic levels.
  • As a reminder the most expensive names are mostly Tech and Secular Growth and the cheapest are mostly Cyclicals including Financials and the commodity sectors.
  • This is important because to the extent that part of the YTD rotation is about pulling out the pandemic related froth from Growth stocks, a lot of that work has already been done as well.

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  • Fourth, retail investor sentiment is back to pandemic lows.
  • A week ago, we flagged that net bullishness on the AAII survey had gotten very close to pandemic lows, which also tends to be the low end of its historical range.
  • In the latest update, this indicator officially got there. Net bulls fell to -29.8% -- right in line with 2020’s low of -29%. On a four week average, this indicator is now at -17.4%.
  • This is important because below the -10% threshold on the four week average, the S&P 500 has been up 15% on average over the next 12 months 86% of the time. A 15% rally off of Thursday’s low would take the S&P 500 back to 4,975 – not too far below our own year-end S&P 500 price target of 5,050.

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  • Fifth and finally, Small Cap futures positioning is on the cusp of net short territory, and isn’t too far above where it bottomed in March 2020.
  • Small Caps are often treated as pure plays on macro hopes and fears and their rough start to the year has been one of the things that’s unsettled us the most to start the year.
  • In last week’s CFTC update (reported late Friday, reflecting Tuesday pricing), Small Cap positioning declined for the third week in a row and came very close to net short territory.
  • Though this indicator isn’t close yet to historical lows (seen in the Financial Crisis and the earnings recession of 2015-2016), it is close to March 2020 lows, when it entered net short territory for a very brief period of time.

Tying it all together….

  • To those wondering if we think we need to cut our year-end target, our answer is no, not right now. If economic forecasts and earnings hold up, sentiment is likely at its low point, pandemic valuation premiums seem mostly out, the Fed seems mostly priced in, and Small Caps are very close to looking oversold.

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  • We also think it’s important to listen to what the market is trying to tell us here. So far, the S&P 500 drawdown hasn’t cracked 10% at the close, which is telling us that the market hasn’t been ready to price in a growth scare just yet.

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  • Clearly that could change, and if it does, the stat to remember is that when those have happened in the post Financial Crisis era, the drawdowns have tended to be in the -15% to -20% range. Actual recessions tend to see the S&P 500 fall more sharply, around 33% on average.

Flip to Industries in Motion page

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 equity analysts.