Welcome to RBC’s Markets in Motion podcast, recorded December 12th, 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.
Today in the podcast, we reflect on hot topics and some of the most interesting things we saw and heard last week. Three big things you need to know: First, we run through the main topics in our conversations with European based equity investors last week. Second, expensive US valuations relative to Europe are another problem for the US equity outlook in 2023. Third, we highlight initial thoughts on potential sector beneficiaries of a weaker US Dollar and China reopening.
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Now, the details.
Takeaway #1: Main Topics In Our Conversations With European Based Equity Investors Last Week
- We spent last week meeting equity investors throughout Continental Europe in a number of countries.
- Many meetings started out with a fairly positive tone and pride regarding how European equities have been outperforming US equities recently. While few articulated an outright bullish view on Europe, the idea that governments were doing a lot to prop things up was noted alongside mounting uncertainty about the US.
- That being said, most of the investors we met with saw risk to the view that the US equity market will have a tough year in 2023 with a weak first half and better second half, simply because that view has been extremely consensus in sell-side outlooks of late. Both upside and downside risks – what could be better than expected, what could be worse than expected – were explored.
- Key questions involved which sectors in the US would benefit the most from US Dollar weakness (a trend in place since October) and China’s reopening (where the discussion still seems early days).
- Interestingly, inflation (and as a result interest rate assumptions) seems higher among the European based investors we spoke with last week than many of those we’ve spoken with in the US recently. While consensus forecasts as tracked by Bloomberg are calling for CPI, PCE, and core PCE to return to around 3% at YE 2023, 4% or higher was mentioned in a number of our meetings for inflation generally.
- As usual, sector views were a hot topic, particularly Tech (with interest in our observation that the rate of upward EPS estimate revisions for Semis has been near historical lows, but Software still has plenty of room to fall), ….
- Health Care (where most agreed with our assessment that the sector is no longer cheap), Staples (where we didn’t encounter too much pushback on the idea that it’s become highly overvalued and fundamentals are at risk if the economy is worse than expected), and Industrials (where we noted that the sector is expensive but may be starting to transition into the next big growth story due to reshoring), and REITs (given the general interest we sensed in high dividend yield plays).
Moving on to Takeaway #2: Expensive US Valuations Relative To Europe Are Another Problem For The US Equity Outlook In 2023
- In our conversations about European equity outperformance, investors were quick to highlight how US equities are expensive relative to European equities, something our work confirms.
- Most also noted that European equities typically outperform non-US equities when Value is beating Growth. Our work also confirms that the Growth/Value trade has been mostly positively correlated with the US/non-US equity trade over time, and that a leadership shift back to Value should, in theory, be accompanied by a shift in leadership back to non-US equities. The correlation between Growth/Value and US/non-US has admittedly broken down recently and recent outperformance by Europe may represent the start of a recoupling of these two themes.
Wrapping up with Takeaway #3: Potential Sector Beneficiaries Of A Weaker US Dollar & China Reopening
- In our discussions of how the 2023 outlook among sell-side strategists seems extremely consensus, we suggested that this may be because everyone is still mostly talking about the same old plot points – inflation, the Fed, the timing/depth/duration of a US recession, and the ongoing overhang of Russia’s invasion of Ukraine. Perhaps this is why the investors we spoke with seemed so excited about the recent weakness in the US Dollar and China’s reopening. They are new things to talk about for 2023.
- In terms of what sectors may benefit from a weaker US Dollar, our work suggests that within the S&P 500, EPS revisions trends for Industrials, Materials, Staples, and Tech are most sensitive to US Dollar trends and may stand to benefit most from a return of US Dollar weakness.
- International revenue exposure is also higher than other sectors for Tech, Industrials, and Materials.
- That being said, we caution investors that the year-over-year trend matters most and that at current levels, the DXY would not stop showing gains on a year-over-year basis until late in 2Q23, meaning that currency pressures will still be in place a while longer.
- On the topic of China’s reopening, revenue exposures are tougher to identify given that most companies report geographic revenue exposures in regional terms (i.e., Asia Pacific) as opposed to country terms (i.e., China). But our review of 2021’s data suggests that Tech and Materials have the highest revenue exposure to Asia Pacific.
- In light of the popularity of both of these questions, it’s worth noting that Industrials, Staples, and Tech have all outperformed over the past month within the S&P 500, while Materials has been improving in recent trading as well. This suggests to us that if nothing else, the stock market is likely to be sensitive to any new themes that emerge as 2023 gets underway.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.