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Welcome to RBC’s Markets in Motion podcast, recorded March 4th 2022. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we run through the takeaways from our latest Macroscope report, our big monthly chart book in which we update our thoughts on the US equity market outlook from both a top down and bottom up perspective – we look at the S&P 500, stocks vs. bonds, US vs. non-US, growth vs. value, sectors, small cap, industries, and factors. We know all eyes are focused on Russian and Ukraine, but thought it was important to pause and reflect on where things are at this particular moment in time.
Three big things you need to know: (1) First, we continue to see a path for the S&P 500 to our 2022 year-end price target of 5,050, but remain mindful of risks to our view. (2) We’re getting closer to an inflection back to Growth leadership. (3) Small Cap outperformance vs. Large Cap since early February seems deserved, but we suspect it will be short-lived.
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Now, the details.
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- Takeaway #1: We continue to see a path for the S&P 500 to our 2022 year-end price target of 5,050, but remain mindful of risks to our view.
- We’ve talked a lot about why we think the Russian invasion is similar to the growth shocks of 2010, 2011, 2015-2016, and 2018. If we assume that the S&P 500 falls 17.3% from peak to trough to ~3,967 – the average of those drawdowns
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- – then sees its typical rebound of 27.8% over the next 10 months, you get to 5,070 on the S&P 500 at the end of the year.
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- We’ve also updated our year-end target analysis, which is based on 15 economic, sentiment, valuation, and cross asset models - 5,043 is still the median of the various scenarios that we looked at.
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- We’ve talked a lot in recent weeks about how we think a lot of the pain from inflation and the Fed has been priced in – we’ve already seen the typical P/E contraction that we tend to see in hiking cycles,
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- and bears in the AAII survey have been so dominant it’s sending a strong contrarian signal to buy the market on a 12 month view. There’s no change in our thinking there.
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- Updating Macroscope also reminds us about other pillars of supports in place for equities – strong corporate balance sheets with high cash balances, receding debt levels,
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- buyback and dividend activity that’s on the mend,
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- and stable earnings growth forecasts – we’ve seen the implied growth rate on 1Q come down from 6% to 5%, but full-year 2022 EPS is still holding steady on the bottom up consensus stats at $225.
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- In terms of the economy, consensus GDP forecasts are still well above trend,
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- US economic surprises are back in positive territory,
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- and the high frequency indicators we track still point to healthy consumer behavior
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- and somewhat less intense supply chain problems.
- The resiliencies we’re currently seeing in the economic and earnings outlook could clearly change – and we’ll be nimble with our forecasts if they do. The risks have clearly grown but haven’t eclipsed our base case.
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- Takeaway #2: We’re getting closer to an inflection back to Growth leadership.
- Value has been beating Growth since November, but over the past few weeks it looks like Growth is trying to stabilize.
- Our call since last August has been that Value would lead early in 2022, with Growth leadership reemerging later in the year.
- Everyone wants to know what we’re watching that will help identify the pivot. When we look across all of our indicators, a number are favoring Value less, or shifting back towards Growth’s favor.
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- Let’s look at these one by one:
- On the Fed - liftoff later this month is an important mile marker – Value tends to lead before hikes, with Growth leadership taking back over during the hiking cycle.
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- On Valuations – these still technically favor Value, but much less so – the Growth/Value P/E has narrowed to pre-pandemic levels,
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- Growth is looking undervalued vs. Value on median cash flow and normalized P/E multiples,
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- and Tech has moved back down to neutral on our sector model.
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- On positioning - Growth is starting to look oversold on the CFTC’s Nasdaq futures positioning data.
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- On earnings – the rate of upward revisions no longer favors Value – Growth has improved as Tech has moved to #2 in the sector rankings, lagging only Energy.
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- On geopolitics - The Dollar is strengthening and the US is outperforming non-US – when the US outperforms, that typically helps Growth outperform Value.
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- On the Economy – above average growth is still the current expectation for 2022, which favors Value, but the risk we see is that the Fed and geopolitics will cause GDP to moderate and get closer to average sooner than most expect – that’s good for the Growth trade b/c Growth outperforms when GDP is below average.
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- Wrapping up with takeaway #3: Small Cap outperformance vs. Large Cap since early February seems deserved, but we suspect it will be short-lived.
- Here’s why we think Small Caps have been behaving a bit better than Large Caps lately and may see that resilience last a bit longer:
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- Earnings sentiment no longer strongly favors Large Caps. In our last few updates, Small Caps earnings revisions trends (the rate of revisions to the upside) have been nearly on par with Large Caps.
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- Additionally, sentiment on Mega Caps is slipping. The percent of ratings that are buys among sell-side analysts has started to slip for Mega Cap companies, but continues to inch up for Small Caps.
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- Meanwhile, Small Caps look oversold. Russell 2000 futures positioning among asset managers has been in net short territory for three weeks in a row, and is starting to approach 2019 and 2020 lows.
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- Importantly, the valuation froth has been removed from Small Caps. The forward P/E for the Russell 2000 had fallen back down to 15.4x at the end of February, down from 21x and a return to its long-term average.
- That’s all good news for Small Caps. Here’s why we’re skeptical that any sustained bout of Small Cap leadership will end up being more than a trade:
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- The economy may be poised to cool off. Small caps tend to outperform when GDP is running above trend, and tend to underperform when GDP is tracking below trend.
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- The Fed is another concern. Small Caps typically experience a major peak in performance relative to Large Cap during Fed hiking/tightening cycles, which is about to begin.
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- Meanwhile, Small Cap money flows have gotten off to a weaker start to the year than Large Cap.
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- Importantly, high yield spreads are starting to widen – which usually is accompanied by a major turning point in the Small Cap/Large Cap relative performance trade.
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- Quality also matters. Small Caps do tend to rank lower than Large Caps on key quantitative metrics that are viewed a signals of quality like ROE. When uncertainty rises, as is the case today, investors tend to gravitate towards higher quality.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s industries in motion, for thoughts on specific sectors from RBC’s team of industry analysts.