Welcome to RBC’s Markets in Motion podcast, recorded May 20th, 2024. I’m Lori Calvasina, Head of US Equity Strategy for RBC Capital Markets.
Three big things you need to know: First, Tech has bounced back on performance and earnings revisions but valuations remain a problem. Second, valuations more broadly have started to look less appealing. Third, other updates in our high frequency indicators highlight how pendulums have swung on a few different fronts (namely investor sentiment, election stats, and funds flows).
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Now, the details.
Starting with Takeaway #1: Tech Has Bounced Back On Performance and EPS Revisions, But Valuations Remain A Problem
Trends in sector performance within the S&P 500 have been fascinating to watch recently. Energy’s strength has faded, while leadership from Utilities (where companies have begun to highlight the boost to the power demand from AI) has emerged. Another sector starting to make a move within the S&P 500 has been Technology.
This seems deserved from an earnings perspective, as this sector is now one of the strongest within the S&P 500 on the rate of upward revisions to sell-side EPS and sales forecasts again.
We are sticking with our market weight recommendation, however, as valuations remain quite elevated.
Moving to Takeaway #2: Valuations More Broadly Have Started To Look Less Appealing As Cuts Have Gotten Baked Back Into Stock Prices Again
As we were running through our weekly updates last week, we were struck by how different some of our valuation charts look today than they did a few weeks ago. For example, the median forward P/E of the top 10 names (in terms of market cap ranking) within the S&P 500 has rebounded to more than 28x. A few weeks ago, this stat had gotten down to 25x. This is a concerning data point for the mega cap Growth trade, as this level is quite close to past peaks.
We also we find that valuations have also eroded a bit for Small Caps. The Russell 2000 weighted median P/E has moved back up to its long-term average of ~15x. A few weeks ago, this stat was sitting well below average at levels closer to 14x.
Our sense that valuations have lost some appeal for these important pockets of US equities contributes to our ongoing “neutral” view on the US equity market.
Something else in our valuation work is contributing to this feeling – our main S&P 500 valuation model, which projects a trailing P/E for YE 2024 based on the relationship between the index’s average trailing 4Q P/E and inflation and interest rate alongside consensus forecasts for those macro variables, has been telling us that 5,100-5,300 is fair value for the index at the end of this year if we see PCE moderate to ~2.5% by the end of the year, get 2 Fed cuts, and see 10 year yields return to the 4% level. Broader market valuations seem fair, if the consensus forecast for a couple of cuts pans out.
Wrapping Up With Takeaway # 3: What Else Jumps Out On Our High Frequency Indicators. The image of a pendulum that’s swung all the back to where it was to start the year, reversing where’s it’s been recently rather quickly, comes to mind for many of these.
- We’ve been on the road speaking with investors consistently over the past few months and our conversations suggest the pivot in the S&P 500 has been driven by renewed optimism about the likelihood of getting Fed cuts in the 2nd half of 2024 due to Fed comments, softer labor data, and evidence of consumer pushback on high prices. We have been struck by the speed and distance with which Fed expectations have swung like yet another pendulum over the past few months. The certainty with which some equity investors spoke to us last week about why they think the Fed will cut a few times this year was the polar opposite of comments we heard in February and March where investors expressed certainty that the Fed would not be able to cut this year because the economy was too strong and inflation too sticky. Last week felt like January again on this point.
- Another pendulum that’s swung in a way that doesn’t quite sit right with us is investor sentiment generally. AAII net bulls came in at more than 17% last week for the 2nd week in a row, not too far from levels that are one standard deviation above the long-term average (21%) which were also in place to start the year.
- Moving to politics, we’ve also been keeping a close eye on a chart we highlighted a few weeks back showing how US/Europe performance within equities has been tracking the Trump/Biden spread in betting markets. We have suspected this is because many non-US investors have perceived Trump winning as negative for Europe from a foreign policy perspective. We’ll continue to track this chart closely to see if the relationship endures, but for now we note that the recent bounce back in US equities has coincided with some modest gains by Trump not only in betting markets but in the national polls and a few swing state polls as well.
- And finally, we note that whatever was pressuring US funds flows recently seems to be resolving. Outflows from US money market funds (both retail and institutional) and US equity funds have reversed course and have turned positive again per EPFR data. Within the US equity category, the improvement has been driven by Large Cap equity funds, primarily passive funds.
That’s all for now. Thanks for listening. And please if you’re a fan of our work, don’t forget to vote when those II ballots come around.