Welcome to RBC’s Markets in Motion podcast, recorded April 17th 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, we tackle hot topics the most interesting things that crossed our desk last week. Three big things you need to know: First, some US equity investors have been frustrated that the stock market seems to be ignoring an upcoming recession, but it’s happened once before. Second, we are looking forward to an earnings season dominated by new hot topics, as the discussion about inflation and its underlying sources has begun to fade in company commentary. Third, a few other things that jumped out from our high frequency indicators last week are all more tactical in nature - elevated Nasdaq futures positioning, stabilization in Banks, better earnings revisions trends for Growth than Value, and the weakening rotation into non-US equities.
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Now, the details.
Starting with Takeaway #1: Stocks Have Ignored A Recession Once Before
One of the things that’s jumped out in our recent meetings with US equity investors is how many have asked us whether the stock market has ever bottomed before a recession actually got underway. We’ve generally been highlighting our belief that the S&P 500 priced in a recession at its October 2022 low when it had fallen roughly 25% from its January high, just shy of the median recessionary drop in the index dating back to the 1930s of 27%. Fears that aggressive tightening by the Fed would drive the US economy into a recession were a clear catalyst for that move lower.
The price action in Small Caps last year also makes us think the October low in the S&P 500 priced in a recession. Over the summer of 2022, Small Caps also appeared to price in a recession when the Russell 2000’s forward P/E returned to just over 11x (historically the Russell 2000’s P/E bottoms in the 11-13x range).
And Small/Large relative returns moved back to levels that were consistent with a drop in ISM manufacturing into deep, contractionary territory.
Last week, as we were discussing this issue with investors it also occurred to us that there actually is one period in history when the stock market appeared to ignore a recession – 1945. This was the recession that occurred as the US exited World War 2. It was brief, lasting from February 1945 to October of 1945, and was driven by the pivot from a wartime economy to a peacetime economy in which government spending dried up quickly. Unemployment remained low despite the fact that soldiers returning home were competing with civilians for jobs. Stock market conditions were volatile before the recession of 1945. The S&P 500 dropped 43% in the early years of the war (a bit worse than the typical recession drawdown), bottomed and pivoted sharply in 1942 between Pearl Harbor and the Battle of Midway (momentum shifted back towards the Allies once the US was fully pulled into the conflict), and rallied strongly through the end of the war (pausing only for a fairly brief 13% pullback in 1943). While there are clear differences between 1945 and today, one thing that both have in common is that unprecedented historical events caused dramatic shifts in the economy that required a tough transition back to more normal conditions. In the case of 1945, this resulted in a technical recession that the stock market was able to look past, perhaps due to all the pain it had already taken. Time will tell whether the stock market can look past any recession that occurs in 2023-2024 as the US economy completes its transition into the post-COVID era. It’s worth keeping in mind that while this would be rare, it wouldn’t be entirely unprecedented.
Moving on to Takeaway #2: The Inflation Discussion Has Faded In Company Commentary
With 1Q23 reporting season getting underway, we’ve updated a number of the charts that we’ve been tracking, highlighting trends in commentary on hot topics in transcripts for S&P 500 companies. The big things that jump out to us is that commentary levels appear to have peaked and are in the process of declining for all of the inflation-related topics we’ve been watching including inflation itself,supply chains,and pricing.
Interestingly, commentary on recession,Uncertainty,and layoffs also appears to have peaked. This echoes what we saw in the Duke CFO survey a few weeks ago, which suggested that C suite confidence was starting to improve prior to recent banking events.
We’re excited about the idea of companies focusing on new issues this year. Beyond the secondary impacts of recent events in banking, it remains to be seen exactly what these new hot topics will be. We’ve read through all of the early S&P 500 reporters from the past few weeks. Outlooks seem to be baking in some conservatism on interest rates and the consumer. While higher uncertainty has been acknowledged, the tone hasn’t been alarmist.
Direct impacts from the banking crisis continue to be described as minimal with banks’ regulation and impacts on lending in focus (on the latter, topic, we found it comforting that one big bellwether bank indicated they would not tighten unreasonably due to recent events).
Commentary on inflation, supply chains, and pricing has highlighted where pressures are moderating, trends are improving, and strategies are flexible.
Softness in consumers/demand has been acknowledged by some, while others emphasize resiliency.
Wrapping up with Takeaway #3: What Else Jumps Out From Our High Frequency Indicators – it’s all fairly tactical in nature.
Nasdaq futures positioning among asset managers isn’t back to peak yet but is getting close. When it does, it may signal a short-term peak in stocks broadly as was the case last August.
Banks continue to stabilize, a positive for the broader market. This reflects increasing confidence the recent banking crisis will likely end being a contained implosion like Worldcom or LTCM.
Earnings revisions trends have been stronger for Growth than Value recently, but this may change if Banks results remain strong and firmer oil prices boost Energy revisions.
Flows to foreign equity funds have faltered, the US no longer looks highly overvalued vs. Europe, and futures positioning by asset managers in EM equities has stalled suggesting the rotation out of US equities into non-US equities has lost steam and fundamental justification.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.