Four big things you need to know: First, investor sentiment has gotten as extreme as it did last August and this past March. Second, earnings season is off to a solid start, but we are still looking for some additional evidence in support of the idea that we’re seeing a durable leadership shift rather than a short-term rotation trade. Third, we’ve been monitoring our other high frequency indicators for clues on the rotation trade. Some suggest the rotation trade has room to run but others are less clear. Fourth, we highlight what we’re watching in the equity market regarding the US election and our initial thoughts on how Biden’s decision to withdraw may impact US equities.
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Welcome to RBC’s Markets in Motion podcast, recorded July 22, 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.
Four big things you need to know today: First, investor sentiment has gotten as extreme as it did last August and this past March. Second, earnings season is off to a solid start, but we are still looking for some additional evidence in support of the idea that we’re seeing a durable leadership shift rather than a short-term rotation trade. Third, we’ve been monitoring our other high frequency indicators for clues on the rotation trade. Some suggest the rotation trade has room to run but others are less clear. Fourth, we highlight what we’re watching in the equity market regarding the US election and our initial thoughts on how Biden’s decision to withdraw may impact US equities.
If you’d like to hear more, here’s another five minutes.
Now, let’s jump into the details.
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Starting with Takeway #1: Investor Sentiment Has Gotten as Extreme (on the Bullish Side) as It Did Last August & This Past March
- As of July 18, net bulls came in at 29.4% with the four-week average hitting 22.2% – a little more than one standard deviation above the long-term average. Net bulls were at similar levels last year in early August, before the S&P 500 fell more than 10%, as well as in February through early April this year, before the index fell more than 5%.
- Last week’s turbulence in the S&P 500 came after some major election-related developments and a fierce repricing of the beneficiaries of Fed cuts following last week’s CPI print. Cross-currents are complex. It’s important to remember the stock market has seemed due for a breather, and that sentiment can get stuck around these levels for a little while before retreating.
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Moving to Takeaway #2: Earnings are off to a solid start, and we’re looking for evidence that the leadership shift from Large to Small and Growth to Value is durable.
- On the overall strength - beat rates are strong so far, on EPS and sales. Commentary in earnings calls suggests also suggest companies are managing through challenges, and that demand conditions are stable despite more intense reactions to higher rates and inflation. Election commentary is picking up, the pick up in capital markets activity has been a key theme. And the tone around AI has been better than what we saw at the start of 1Q season.
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- On the leadership shift, S&P 500 continues to no longer have an advantage over the R2000 on earnings sentiment (the rate of revisions to the upside). This is good news for the rotation trade into Small Caps, but we’d like to see this indicator flip fully in their favor to gain some conviction a longer-term outperformance cycle in Small Caps is starting up rather than just another short-lived reversion trade.
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- Mega cap growth remains dominant relative to the rest of the S&P 500 on EPS revisions, an ongoing challenge for the shift to Value.
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Next, Takeaway #3: We see some mixed signals for the rotation trade in our other high frequency indicators.
- One data point that dampens our enthusiasm on Small Caps is that the move in the R2000 vs. the S&P 500 has been similar in magnitude to the one seen last November and December.
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- Another is that Small Caps no longer look cheap, with the Russell 2000 forward P/E back to average already.
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- On the other hand, positioning in R2000 futures has surged but isn’t back to late-23/early-24 highs yet. This points to more room for small cap part of the rotation trade to run.
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- Flows data is also showing a shift into Small, Value, and Cyclical sectors and away from Growth and Tech, though overall US equity flows remain strong.
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Wrapping up with Takeaway #4: what we’re watching on the US election.
- First, betting markets. We’re keeping a close eye on whether the relationship the US equity market has seen with Trump’s perceived chances of winning will persist. Throughout 2024 there’s been a positive correlation between the two, with the S&P 500 hitting it’s YTD high as Trump hit his own in betting markets. We’re watching to see if this relationship holds up.
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- Second, flows. US equity funds have been seeing consistent inflows throughout 2024 while flows to Europe have been negative. Our conversations with non-US-based investors since last summer have led us to believe that Trump’s America First agenda has been seen as positive for the US and negative for Europe by global investors. There’s been no change in these flow patterns of late.
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- Third, policy commentary. Last week, investors debated what the implications of a 2nd Trump Administration would be for Tech, a reminder that election years are a discovery process in which investors must learn, digest, and price competing policy views. It will take some time for Harris’s agenda to emerge if she is the nominee. Our work from 2020’s primary suggests that she was seen as a little tougher on Energy and Financials than Biden, but, like Biden, less onerous for Big Tech than Warren and Sanders. We suspect her views have evolved, but this seems like a good place to get started.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.
