US Equity Market Outlook Update Pt 1 - Transcript

Welcome to RBC’s Markets in Motion podcast, recorded May 30th, 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. We’ve just published a new report taking a deep dive into the US equity market outlook looking at the S&P 500, stocks vs. bonds, US equities vs. non-US equities, Growth vs. Value, and small cap. In today’s podcast, which we consider to be part 1 of this outlook update, we’re going to be focusing on our S&P 500 forecasts and broader market calls. Two big things you need to know:

  • First, we are lifting our YE 2023 S&P 500 price target from 4,100 to 4,250, which represents our base case. The range of outcomes in our modeling spans ~3,800 (our bear case) to ~4,600 (our bull case).
  • Second, we are lifting our 2023 S&P 500 EPS forecast to $213 from $200 and are introducing our 2024 EPS forecast of $223

If you’d like to hear more, here’s another six minutes.

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Now, the details.

Takeaway #1:  we are lifting our YE 2023 S&P 500 price target from 4,100 to 4,250, which represents our base case.

  • Our target is roughly the average of six different economic, sentiment, valuation/earnings, political, and cross asset models that we employ.
  • Our least constructive model sees the S&P 500 flat for the year and coming in around 3,800 - our bear case. Historically, the median return in the S&P 500 is flat in years that see 0-2% real GDP, which is in line with the current consensus forecast for 2023 of 1.1%.
  • Our cross asset models bake in the greater appeal of bonds relative to equities by examining how stocks perform when the dividend yield and earnings yield appeal of US equities has turned low relative to 10-year Treasuries.
  • Those models argue that the S&P 500 deserves to end the year in the 4,000-4,100 area for low single digit annual gains.
  • Our sentiment, political, and valuation tests are most constructive and suggest the S&P 500 could end the year much higher in the 4,400-4,600 range. They capture a few different ideas…
    • One of these is that that the stock market usually does very well in 3rd years of a presidential cycle, rising more than 16% on average…
    • Another is that US equity market returns tend to be powerful when investor bearishness is as deep as it was to start the year and became again after the regional banking crisis. More specifically, when AAII net bullishness is at -10% in favor of the bears or more (as it was to start the year and still is today) the S&P 500 typically rallies 15% over the next 12 months.
    • Other metrics also point to peak fear having been seen among institutions. These include the MOVE index, which measures bond market volatility and hit LTCM highs earlier this year…
    • and CFTC data on leveraged funds net short positioning in S&P 500 e minis, which has been near historical lows.
    • Our valuation test is the most bullish of them all, however, and suggests that moderating inflation and stabilizing interest rates could allow the trailing P/E in the S&P 500 to move up to around 21.8x at year end. Couple with our $213 EPS forecast for 2023, this argues that S&P 500 could breach 4,600.
  • Looking beyond these models, our work points to other reasons to temper both optimism and pessimism. Those are too numerous to highlight in this podcast, even considering we’re breaking it up into two parts. So we’ll highlight two of our favorite charts – one bullish and one bearish.
    • On the constructive side, one of the newer, more eye catching charts we’ve published addresses the question of what tighter lending standards mean for the stock market. We were surprised to find that since the GFC, the S&P 500 has actually tended to bottom before the peak in C&I lending standards.
    • On the more cautious side, we’d also note that current stock market pricing appears to already bake in the concept of recovery in 2024 on both earnings and the labor market. As confidence in that 2024 recovery ebbs and flows, so too may S&P 500 performance.

Wrapping up with takeaway #2: we are lifting our 2023 S&P 500 EPS forecast to $213 from $200 and are introducing our 2024 EPS forecast of $223.

  • On our 2023 number of $213 –
    • The upward revisions vs. $200 comes mostly from ongoing efforts to fine tune our margin assumptions which came in better than we expected in 1Q. We’ve also added some modest benefit from buybacks, though at a slower rate than what we’ve seen in recent quarters, and are baking in inflation that ramps down to the mid 3% range this year, along with industrial production and GDP forecasts that are weakest in the final two quarters of 2023. As a reminder, we use consensus forecasts as inputs for macro variables in our S&P 500 models since we think that’s ultimately what stocks are digesting and reacting to.
    • We are a still a little below the sell-side bottom-up consensus of $220 – but we wouldn’t over think this. Generally, we’re feeling better about the earnings backdrop. The rate of upward EPS estimate revisions for the S&P 500 has turned positive again…
    • bottom-up estimates tend to reflect reality by mid-year based on our study that looks at all earnings

downgrade years going back to 2009, and…

  • stock price were already baking in a very onerous earnings backdrop last year.
  • On our 2024 number of $223 – We get asked about this in almost every meeting, which tells us investors clients are already looking ahead to 2024. We view this forecast as very preliminary – it bakes in the idea that that CPI will fall to about 2% at YE 2024…
  • real GDP and industrial production will recover in the back half of the year, Fed cuts will occur, and 10-year yields will drift a bit lower. Again, this is all what the consensus economic forecast is projecting and our earnings forecast will continue to be revised as those projections evolve.

That’s all for now. Stay tuned for part 2 of our outlook update in podcast form – where we’ll run through our thoughts on positioning including the Large Cap Growth trade and Small Caps. Thanks for listening, and be sure to reach out to your RBC representative with any questions.