Welcome to RBC’s Markets in Motion podcast, recorded June 16th, 2024. 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, the continued outperformance of mega cap Growth stocks has been logical, but still somewhat jarring to us. Second, Small Caps broke to clear new lows relative to Large Caps last week as risks piled up including a Fed that seems inclined to cut just once this year. We’d stay on the sidelines with Small Caps for now. Third, investor sentiment continues to concern us, and we’ve added consumer sentiment to our list of worries for the stock market following the Michigan survey miss. One offset is that the US may benefit from safe-haven seeking if flows to European equity funds deteriorate.
If you’d like to hear more, here’s another 5 minutes.
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Now, let’s get into the details….
Takeaway #1: The Mega Cap Growth Trade Surges Again
The most striking chart in our deck this week’s highlights how the biggest market cap names in the S&P 500 have continued to outperform the rest of the S&P 500 massively, despite the recent decline in 10-year Treasury yields. With this recent move, the close, positive correlation between the leadership of mega cap Growth stocks and 10-year yields that has been in place since the regional banking crisis in early 2023 appears to be decoupling.
What’s driving the mega cap Growth trade instead? One thing is that GDP forecasts are headed to below-trend levels and have stopped improving which tends to be a better environment for Large Cap and Growth than Small Cap and Value.
Additionally, better EPS revisions trends returned to the biggest names at the end of the last reporting season.
We’re also seeing less pressure from crowding per CFTC’s weekly data on Nasdaq futures positioning. The renewed strength in the mega cap Growth trade makes sense, but is a bit jarring to us in that one big issue seems to be that fundamental tailwinds are dissipating with some headwinds emerging.
Moving on to Takeaway #2: Small Caps Sink, as Risks Pile Up
Last Wednesday was a confusing day for US financial market participants. It began with a surprisingly dovish CPI print and ended with a surprisingly hawkish Fed meeting. The charts we were watching on our screen all day, particularly during Powell’s press conference, track the ratio of the Russell 2000 relative to the S&P 500. By the time the day was done, Small Caps had given up almost all of the outperformance they’d banked relative to Large Caps in the early trading hours of the day.
As the week wore on, investors digested the reality of a Fed leaning towards only a single cut later this year, challenging political dynamics in Europe, and escalating concerns about the impact of inflation on the US consumer. Though the S&P 500 held up fairly well, it was all too much for Small Caps which sunk to a new low relative to Large Caps, a much lower relative ratio than what we’ve seen in recent years.
We’ve been neutral on Small Caps relative to Large Caps, noting that while CFTC positioning for Small Caps has looked compelling (down around SVB lows) and relative valuations for the R2000 vs. the S&P 500 have been cheap…
… the Russell 2000’s own P/E has been looking only average. Slowing GDP growth forecasts to below-average levels have also removed an important tailwind.
We’ve also pointed out that earnings revisions trends have been stronger for Large Caps lately …
… and that Small Caps typically only outperform after Fed cuts begin, not beforehand.
We continue to think investors shouldn’t overthink the Small Cap call. We see enough that looks interesting to stay neutral for now and think that when it’s finally time to put on Fed rate cut trades this space will do well. But we think it’s unwise to move back to an overweight until the beginning of the cutting cycle is closer and economic tailwinds strengthen again.
Wrapping up with Takeway #3: What Else Jumps Out on Our High Frequency indicators
To begin with, investor sentiment continues to concern us. AAII net bulls continue to flirt with readings close to 1 standard deviation above the long-term average. CFTC positioning on the broader US equity market also continues to look stretched, driven by elevated positioning in S&P 500 futures.
Additionally, Consumer sentiment is a new worry on our radar. Our review of earnings call transcripts and presentations at RBC’s Consumer & Retail Day have been indicating that inflation and interest rate pressures on consumers had escalated. But Friday’s big miss on Michigan’s consumer sentiment was still concerning from an equity market perspective as performance for both the Russell 2000 and S&P 500 (on a yr/yr basis) has been tracking moves in this index quite closely in recent years.
Sector wise, it’s worth noting that Communication Services, Financials, and Industrials have been most aligned with consumer sentiment over time. In this context, it wasn’t surprising to us that Industrials was the worst performing S&P 500 sector on Friday. By contrast, Tech tends to be one the sectors that trades most inversely with trends in consumer sentiment, offering another reason for old market leadership to return.
And finally, in light of the political developments in France last week, we’re keeping a close eye on EPFR’s flows to European equity funds (page 87). These had been improving and were back in slightly positive territory. We wouldn’t be surprised to see those turn negative in coming weeks, which could be accompanied by improving flows to US equities as investors seek safer havens.
We’ll end with one more reminder to vote in II – mercifully, that election will be over much sooner than the US Presidential election as the survey will close on June 28th.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative.