Welcome to RBC’s Markets in Motion podcast, recorded Sept 26th, 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, three big things you need to know:
- First, the stock market tends to experience turbulence heading into extended government shutdowns, but the S&P 500 has already done more than half the damage typically seen in those episodes and rebounds that follow tend to be powerful.
- Second, we view last week’s Fed meeting as a mixed bag for Growth stocks – negative short term but positive long term.
- Third, things that jump out from our high frequency indicators include continued erosion in investor bullishness, Trump pulling ahead of Biden in the polls, and strong outperformance by Utilities this month.
If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple and Spotify. Now, the details.
Takeaway #1: US Equities Tend To Be Turbulent Heading Into Extended Government Shutdowns, But Half the Typical Damage Has Already Been Done Since July
- With the possibility of a government shutdown back on investors’ radars, we took a close look at extended shutdowns, or the ones that have lasted 10 days or more, since the 1970’s. US equity market declines during the dates the government was actually shut down have tended to be rather mild with a median decline of 2%. And in one instance (the shutdown that occurred in late 1979) the S&P 500 even continued to move up after the shutdown began before dropping sharply.
- Importantly, when we zoomed out, we also found that the US equity market has usually experienced a decent sized pullback heading into extended shutdowns which were, on an average and median basis, around 10%.
- In recent episodes, the shutdowns were one of several factors contributing to equity market turbulence and we think it’s fair to assume the same was probably true in the past as well. Fraught politics tend to be a symptom of challenging times generally. The good news for US equity investors today is that at the time of this recording, the S&P 500 has already fallen more than 6% from its late July 2023 high. A 10% drop, which would be in line with the average and median pullback heading into extended shutdowns in the past, would take the index a little north of 4,100.
- The other thing we’d encourage US equity investors to keep in mind as the politics around a potential shutdown evolve is that US equity markets have tended to rebound meaningfully after the pullbacks associated with extended shutdowns, with 12-month forward gains of 18-19% on an average and median basis.
Moving to Takeaway #2: We See Last Week’s Fed Meeting As A Mixed Bag For Growth Stocks
- We’ve talked a lot recently about how Large Cap Growth stocks have looked over owned, based on our interpretation of CFTC’s weekly data on asset manager positioning in Nasdaq 100 futures…
- We’ve also talked a lot about how they’ve looked overvalued. More specifically, the R1000 Growth index’s P/E hit peak levels relative to Value earlier this year and the correction still seems early.
- We’ve also highlighted how Growth has been losing its dominance relative to Value on earnings revisions, which illustrates how an important tailwind for Growth stocks has diminished.
- Overall, we’ve thought that Growth stocks have been a plain old fashioned crowded trade in need of a tactical correction.
- The emphasis on higher for longer in last week’s Fed meeting, modestly lowered expectations for 2024 cuts, and spike in bond yields, give Growth stocks a new reason to continue their tactical correction at a time when conditions remain ripe for them to do so.
- That being said, it also struck us as important that while GDP forecasts were revised higher in the SEP, that the improved view on 2024 only took the forecast to 1.5% and that the 2025 GDP forecast remained at 1.8%. Both stats are below the long-term average for GDP growth since the late 1970’s. And our work has shown that Growth stocks tend to outperform Value stocks when GDP is running below trend. While we continue to expect near-term underperformance in Growth stocks, which is a headwind for the stock market in the here and now, we think an opportunity is building for longer-term investors.
Wrapping up with Takeaway #3: Other things that jump out from our high frequency indicators
- First off, and perhaps most importantly ,individual investor sentiment has continued to retreat. Net bulls in the weekly AAII survey fell to 3.28% on the four-week average last week. While it’s not yet fair to say pessimism has gotten too extreme, this is an important development since this indicator had been flashing red in early August when net bullishness was 2 standard deviations above its long-term average. The unwind in sentiment that’s helped explain the weakness in the US equity market since late summer is in the process of playing out, but isn’t done yet.
- Second, Trump is pulling ahead of Biden in the polls. As investors continue to wonder when equity markets will start focusing on the 2024 election, we found it interesting that data from RealClearPolitics.com shows Trump has pulled slightly ahead of Biden in their poll of polls. One thing that’s come up in our conversation about the shutdown this week is that it seems like politics will be difficult for markets to digest and price for the time being.
- And third, Utilities has been the top performing sector within the S&P 500 recently, but we’d stay on the sidelines.
- Flows to Utilities dedicated funds have also picked up.
- Valuations on the sector have improved but still don’t look cheap on our model.
- Earnings and sales revisions trends have also been a bit weaker than other sectors.
- We remain market weight and prefer Health Care as a defensive alternative.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.