Welcome to RBC’s Markets in Motion podcast, recorded May 7th, 2024. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers. Three big things you need to know: First, after a weak start to 1Q24 reporting season, it has settled into a groove on the stats. Second, we review our thoughts on key themes on company earnings calls so far. Third, we highlight what’s jumping out on our high frequency indicators. This includes our main sentiment indicator (which we still think hasn’t fallen enough) and our rundown of the key headwinds and tailwinds for Small Caps (which both weakened last week).
If you’d like to hear more, here’s another 5 minutes.
Now, let’s jump into the details.
Starting with Takeaway #1: Earnings Season Settles into a Groove on the Stats
Last week we noted that after a weak start, reporting season had started to find its footing. Today, we’d take that a step farther and say it’s settled into a groove. Here’s what jumps out so far:
- It’s continued to be a better reporting season from an earnings perspective than a revenue perspective. Our recent stats show that 77% of S&P 500 companies were beating consensus on EPS while 59% were beating consensus on revenues. Trends are similar for the Russell 2000. The sizable gap we’re seeing between EPS and revenue beats has been in place for a few quarters on both indices and suggests to us that companies are doing a good job of managing results to meet or beat expectations.
- Large Cap stock price reactions to EPS beats have turned positive. We are now seeing mostly outperformance among the stocks that have beaten consensus on EPS so far within the Russell 1000, reversing the underperformance that had been seen among the earliest reporters. Companies beating expectations on EPS are also outperforming within the Russell 2000.
- The bottom-up consensus EPS forecast for the S&P 500 for 2024 has moved up again. This stat is now tracking at $245, up from $242 a few weeks ago and $244 last week.
- Old leadership continues to look tired from an earnings sentiment perspective. Our preferred gauge of EPS sentiment, the percent of sell-side EPS estimate revisions to the upside, has been a little bit stronger for Value than Growth recently.
- We’ve also started tracking this stat for the top 10 market cap names in the S&P 500 relative to the rest of the index. Recently, we’ve started to see a slightly stronger rate of upward revisions (i.e., better earnings sentiment) for the rest of the market. This reverses conditions in place throughout 2023 when earnings sentiment for the top 10 names was stronger.
Moving on to Takeaway #2: Our Rundown on Emerging and Evolving Themes on Earnings Calls So Far
As our regular readers are well aware, our team reads through as many earnings transcripts as we can to get a feel for key themes. Things that jumped out to us in last week’s reading include:
- Perceptions of the outlook, demand and macro backdrop were mixed with a number of companies emphasize better conditions in the 2nd
- We didn’t read anything new about the consumer last week, but do note that the tone seemed to skew more negatively than prior weeks and the past few reporting seasons.
- On the cost environment, some noted that inflation and pricing were normalizing.
- On the Fed and interest rates, several companies highlighted the return of uncertainty on this topic and the impacts of high costs of capital and debt.
- Commentary on China and Europe has been much more mixed (far less negative) than what we’ve seen in the past few reporting seasons.
- AI continued to be a key theme, with more of a positive tone than what we observed at the beginning of 1Q24 reporting season.
Wrapping up with Takeaway #3: What Else Jumps Out from Our High Frequency Indicators…specifically on Small Caps and sentiment.
- Small Caps have been sandwiched between strong headwinds and tailwinds, which both weakened last week. Despite the tough April that Small Caps had amid renewed fears over the path of inflation and the Fed, the R2000 has still not broken to a new low vs. the S&P 500. The reasons for Small Caps’ resilience was a focal point in our meetings last week, even before Friday’s below-consensus print for nonfarm payrolls and slightly higher-than-expected April unemployment rate hike boosted rate cut optimism. We’ve been highlighting how Small Caps are caught between powerful tailwinds and headwinds.
- The tailwinds have primarily been attractive positioning and valuations along with improving economic expectations. On the latter point, we’ve highlighted the apparent bottoming in ISM manufacturing and the recent improvement in consensus GDP forecasts, since Small Caps tend to outperform when ISM manufacturing moves up and once GDP starts to trend above average.
- The primary headwind has been the Fed. Historically, Fed cuts have been triggers for Small Cap outperformance, but the shift in leadership has tended to occur after the event not before. Most of the equity investors we spoke with last week, prior to Friday, didn’t think cuts were coming anytime soon, and worried the idea that inflation will moderate from here is based on little more than hope.
- While an argument can be made that the Fed headwind for Small Caps eased a bit on Friday with the worse-than-expected jobs reports, we think it’s equally important to note that the economic tailwinds for Small Caps also appeared to weaken a little. In our meetings, it was apparent to us that some of the consumer companies that reported last week had heightened concerns about the health of the consumer. While still off its lows, ISM manufacturing also slipped in last week’s update. We wouldn’t be underweight Small Caps right now, but are reluctant to turn overweight in light of these complex cross-currents and prefer a neutral stance.
- And finally…broader market sentiment still hasn’t gotten hit hard enough. Over the last few weeks we’ve argued that our sentiment indicators hadn’t fallen enough to indicate that the current pullback was over, and that remains our view today. We’re continuing to keep a very close eye on the weekly AAII survey, which came into 2024 roughly one standard deviation above its long-term average, similar to where it was last summer when the 10% drawdown in the S&P 500 began. After falling briefly in recent weeks, net bulls moved up in the latest update to 6%, while the four-week average fell to 7%. That keeps our concerns alive that the pullback hasn’t run its course since this indicator fell to more than one standard deviation below the long-term average last fall (which is around -9%) shortly before the S&P 500 established its October-2023 low.
That’s all for now. Thanks for listening and be sure to reach out to your RBC representative with any questions.