Welcome to RBC’s Markets in Motion podcast, recorded March 28th, 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 have updated thoughts on sectors, sentiment, and small caps. Three big things you need to know:
- First, S&P 500 Tech sector valuations have room to run, while EPS and revenue revisions have turned slightly positive – supporting our continued overweight on the sector.
- Second, the body of our sentiment work continues to suggest fear has been approaching potential peak levels, but falls short of providing US equity investors with an all-clear.
- Third, other things that jump out from our high frequency indicators include how economic and earnings forecasts continue to anticipate a 2024 recovery, the return of high quality leadership, and how Small Cap performance relative to Large Cap is at an important crossroads.
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Takeaway #1: S&P 500 Tech sector valuations have room to run, while EPS and revenue revisions have turned slightly positive – supporting our continued overweight on the sector.
- We’ve refreshed our sector models for the new GICS classification changes and taken our valuation model back to the late 90’s. Previously, we started in 2004.
- Tech is middle of the pack vs. other sectors, slightly above it’s LT average on a relative forward P/E but not egregious.
- Something that’s been jumping out to people in our conversations is that it’s Consumer Discretionary that looks most expensive right now within the S&P 500.
- That’s not distorted by any one stock as our stats are based on unweighted medians. But it’s worth noting that Consumer Discretionary looks undervalued within Small Cap.
- Putting valuations aside and getting back to Tech, what we notice on our revisions works is that Tech and Industrials are the only two sectors with positive revisions on both revenues and EPS
right now. That’s a big change for Tech which was in negative revision territory most of last year.
Moving on to Takeaway #2: the body of our sentiment work continues to suggest fear has been approaching potential peak levels, but falls short of providing US equity investors with an all-clear.
- Things that make the stock market look most interesting from a contrarian perspective:
- AAII net bullishness at -28%, below -10% is a buy signal w/a 15% forward return on avg on a 12 month basis.
- Earlier this month, the equity put/call ratio also returned to the highs of 2010, 2011, 2014, 2016, 2018, and 2020 – below last year’s all-time high but still at a level that is typically followed by strong S&P 500 returns on a 12-month forward basis.
- The weekly percent change in money market fund assets, which has been on par with Dec 2018, Oct 2014, Aug 2011, and Aug 2007.
- We’re also watching CFTC data on Russell 2000 futures – this indicator returned to slight net short territory earlier this month but still some room to travel before hitting last year’s all-time low.
- And obviously we’re watching the performance of the Banks, the problem industry of today. The KBW Bank index is trying to stabilize after returning to its late 2020 lows relative to the Nasdaq 100.
- Keeping a close eye on problem industries matters in this kind of environment. We took a look at stock market performance in 2008 around the Bear and Lehman failures and found that while the broader stock market and Tech stocks chopped around after Bear, Banks were weaker, warning of problems to come.
- By contrast, Growth stocks (which were the epicenter of the Tech bubble) stabilized after the Worldcom bankruptcy, which helped a lengthy bottoming process in the broader market start.
Wrapping up with Takeaway #3: other things that jump out from our high frequency indicators include how economic and earnings forecasts continue to anticipate a 2024 recovery, the return of high quality leadership, and how Small Cap performance relative to Large Cap is at an important crossroads.
- While it’s possible Wall Street simply hasn’t updated it’s models yet, we find it striking that economic forecasts in particular are not reflecting an uptick in recession expectations for the US …
- …and still expect to see the negative GDP environment to be contained in 2023. We think the ongoing idea of 2024 being a recovery year is helping the stock market to stay resilient, since a 2023 recession was essentially already priced in to the S&P 500 at the October 2022 low.
- The return of the high quality trade in the Russell 1000,
- as well as the Russell 2000, is also something that may be providing some comfort as that tends to be a good environment for active managers.
- And on Small Caps, the chart that’s burned into our brain is that Russell 2000 performance vs. the S&P 500 returned to May 2022’s low point on Friday.
- Small Caps had a nice move on Monday and that bounce back makes sense to us given that the R2000 P/E is around 13x – historically the index bottoms out in the 11-13x range.
- We may be wrong on this as long as the money is flowing into big cap Tech, we’re longer term by nature and are sticking with our Small Cap overweight, since the index is no longer baking in that anticipated 2024 recovery as was the case to start the year.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.