April 29, 2024: Will April showers bring May flowers?

Key points

• Earnings are a key catalyst to keep the bull market going.

• Mega-cap company reports are important in the short term, with good numbers thus far continuing to support a broadening out of the market.

• Inflecting fundamentals, across different industries and sectors, have created opportunities in under-owned corners of the market.

Last week, sentiment continued to be a rollercoaster ride amid the conflict between generally strong earnings results and macroeconomic data showing a stalled disinflationary cycle and weaker than expected growth.

The repricing to “later and less” rate hikes has been a strong headwind to bonds and equities over the past few weeks. Based on recent data, the U.S. Federal Reserve (Fed) could need to revise its growth and inflation forecasts up in its June summary of economic projections, potentially feeding into a somewhat higher median path for the federal funds rate in the updated dot plot. This will probably be the focus of Wednesday’s press conference, in addition to getting a sense of timing for the first rate cut.

Despite hawkish macro trends, equities bounced back strongly last week.

“I have been adamant that earnings will be the ultimate arbiter of this bull market,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “We’re starting to see this play out: Earnings continue to roll in strong, and investors are rewarding positive outlooks across sectors and industries.”

This week brings the Federal Open Market Committee (FOMC) meeting, the nonfarm payrolls report, and critical earnings reports from two of the largest companies in the S&P 500 Index. While it’s too early to determine if recent volatility has passed, technical metrics, investor positioning, and market sentiment have all reset following an incredible run since October. A weaker dollar and falling gold and oil prices also provide tailwinds for the market to stage a recovery.

Orton cautions to tread carefully in the near term and to be ready to consider deploying capital once the market ultimately settles.

“Selectivity remains critical to success, and I continue to like adding cyclical exposure to complement technology and building balance in portfolios, especially with rates back to generationally attractive levels,” he said.

Last week’s macro data was a mixed bag, making the equity recovery even more meaningful, especially when contrasted with another poor week for bonds. The Bloomberg U.S. Aggregate Bond Index declined for a fourth straight week while the S&P 500 Index posted its strongest week of 2024.¹ Annualized gross domestic product (GDP) growth disappointed at 1.6% in the first quarter, but most of the unexpected slowdown came from a large inventory buildup and a drag from net exports. Without these components, GDP would have been 2.8%, above the 2.5% consensus.

Stagflation — the permabear narrative — doesn’t hold up when looking beneath the surface, Orton said, especially since the underlying stability in final sales indicates a stable consumer outlook. Despite some of the positives from the GDP report, Orton’s near-term concern is that stronger demand and inflation may make the Fed more hesitant to cut rates, leading to more rate volatility weighing on equities.

“This is further evidence that investors don’t need to rush to buy the dip,” he said. “Be selective and consider looking for opportunities where growth is inflecting and/or accelerating higher.”

Of course, the key reason to remain optimistic is the trajectory of earnings, Orton said. Halfway through the first-quarter earnings season, more than 80% of the S&P 500 Index constituents reporting so far have delivered better than expected growth in earnings per share (EPS), with more than 50% reporting surprises on revenues. Even healthcare, the biggest drag on EPS growth, has so far reported 100% positive surprises on sales. The mega caps have also largely delivered.

“As long as the fundamental earnings backdrop remains in place, the market can go higher,” he said. “It’s our job as investors to find where fundamentals are strongest and to lean into those parts of the market.”

Themes to consider

Key themes have been playing out nicely over the past few weeks sustaining Orton’s optimistic outlook, particularly once macro uncertainty starts to decline.

While he said there are risks in the very short term, positive factors include bitcoin’s resilience, a faltering U.S. dollar, and consolidation in gold and oil. Overseas, European banks are performing well with earnings showing broader signs that the bottom might be in, and Chinese stocks are transitioning from bearish to bullish trends. However, some weakness should be expected after five months of gains off the October bottom last year.

Predicting the number and timing of Fed rate cuts might produce some immediate trading gains, but isn’t going to win the long game in equities. “Selectivity is critical because higher bond yields impact sectors differently,” Orton said, “yet I believe there are plenty of opportunities to diversify.”

For example, energy and banks have higher positive correlations to U.S. 10-year bond yields and, not surprisingly, have performed quite well since the market peak (further aided by rising energy prices and strong earnings). At the same time, some defensive sectors with negative correlations to bond yields, such as healthcare, have struggled and proved they aren’t defensive in a falling market.

In this context, Orton’s investment playbook includes weighing the potential risks and rewards of several areas:

• Leaning into cyclicality. Orton believes selectivity remains critical to success and he continues to recommend thinking about adding cyclical exposure to complement technology. Energy, industrials, financials, and materials have all outperformed the broader markets and provide a hedge to inflationary concerns. He sees industrials as a quality play on the sector’s higher capital expenditures and its leverage to artificial intelligence (AI) through a number of industries, particularly electrical equipment, where earnings in some key companies were very strong last week. Energy, he believes, can be a hedge on inflation and geopolitical risks — oil servicers have lagged the exploration and production names and oil majors — and Orton recommends considering positioning for a bounce. Banks could benefit from less downside to the global economy. In the materials space, copper (at $10,000 a ton) highlights the immense need for the metal across the AI buildout and the push for electrification. Across these sectors, Orton believes there are many opportunities to get into high-quality companies with accelerating earnings growth.

• Working to add balance to portfolios with small caps. The small-cap complex remains challenged despite continued good economic news. However, high-quality small-cap stocks with higher returns on equity, lower leverage, and free cash flows have meaningfully outperformed the broader Russell 2000^® Index for the past month, as rates have jumped recently. It’s also worth noting that the S&P SmallCap 600 Index — typically considered a higher-quality small-cap index — declined a modest 1.3% last week, outperforming the Nasdaq Composite Index by 4.2%. Orton believes that the economic environment will ultimately drive small caps and that earnings season could provide an opportunity for good news on the outlook and a catalyst for a flatlining or a reversal in relative performance.

• Being selective with international stocks. Looking at last week’s fund flows across the global complex, excluding the United States, all regions saw outflows except for Asian emerging markets (EM), which saw marginal inflows. Orton said this showcases why he believes selectivity and balance across international exposures is so important. “I continue to like India given its resilience and idiosyncratic growth drivers,” he said. “Positive momentum in financials continues and I believe European and Japanese banks look quite attractive right now.” The divergence between the Fed and other central banks remains in focus and has set up an environment he thinks is likely to keep the dollar strong and to support exporters across markets like Japan and Europe. Energy companies in Europe also have an opportunity to surprise to the upside as they report earnings, and Orton said he would consider adding exposure with an inflection in EPS growth.

What to watch

It’s another heavy calendar of earnings and macro data releases, headlined by Wednesday’s Fed meeting and Friday’s U.S. job and Institute for Supply Management reports. Tuesday, data comes in on Eurozone first-quarter GDP and inflation during April as well as from the Caixin China General Manufacturing Purchasing Managers’ Index for April.

Orton expects the Fed to keep rates unchanged on May 1, with a focus on Chairman Jerome Powell’s likely diminished confidence around the path of disinflation and the March dot plot. Overseas, it’s Golden Week – national holidays – in Japan and China, so liquidity there will be thin. Earnings reports include larger companies in online retailing, information technology, semiconductor manufacturing and anti-obesity drugs.

¹ Unless otherwise indicated, all data cited is sourced from Bloomberg as of April 26, 2024.

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Raymond James Investment Management or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.

International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.

Definitions
Annualized estimates represent short-term calculations or rates that have been converted into annual rates.

The China Caixin Services Purchasing Managers Index is compiled from responses to questionnaires sent to purchasing executives in more than 400 private service sector companies.

A consensus estimate is a forecast of a public company’s projected earnings, the results of a particular industry, sector, geography, asset class, or other category, or the expected findings of a macroeconomic report based on the combined estimates of analysts and other market observers that track the stock or data in question.

Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.

Correlation is a statistic that measures the degree to which two securities move in relation to each other

Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.

Defensive sectors include companies that tend to have a constant demand for their products or services, making their operations more stable during different phases of the business cycle.

Disinflation refers to the temporary slowing of the pace of price inflation and describes what happens when the inflation rate is marginally lower over the short term. Disinflation refers only to the rate of change in the rate of inflation. In this, it is distinct from inflation and deflation, which describe the direction of prices.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

The Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.

Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset. It typically is measured on a quarterly or monthly basis. Investors and others look at the direction of fund flows for indications about the health of specific securities and sectors or the overall market.

Gross Domestic Product (GDP) is the total value of goods and services provided in a country during one year.

Hawkish, dovish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Centrists tend to occupy the middle of the continuum between tight (hawkish) and loose (dovish) monetary policy.

Headwind is a term used to describe events or market forces that hinder the prospects for performance in an individual investment or group of investments.

Mega-cap tech stocks are the technology companies with market capitalizations that are in the trillions or hundreds of billions of U.S. dollars, levels that far exceed many of the other stocks in the S&P 500 Index.

Permabear is a term referring to an individual who is consistently negative about the future of the markets and economy.

Relative performance (RP) is a measure of a security’s performance compared to a specified benchmark such as a stock index, sector or other group of similar securities.

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity.

Stagflation, first described after the oil shocks of the 1970s, is an economic condition that includes slow economic growth (or even declines in gross domestic product), relatively high unemployment, and inflation.

The Federal Reserve’s inflation target rate is the rate of price increases prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by Personal Consumption Expenditures (PCE) Price Index.

The payroll report, officially known as the Employment Situation Summary, is a monthly U.S. Bureau of Labor Statistics (BLS) report tracking nonfarm payroll employment and the national unemployment rate, with data on changes in average hourly earnings, and job trends in public and private sectors of employment. The report is based on surveys of households and employers.

The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, is known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.

The summary of economic projections is produced following meetings of the Federal Open Market Committee and includes meeting participants’ projections of the most likely outcomes for real gross domestic product growth, the unemployment rate, and inflation for a forward-looking three-year window and over the longer run.

The U.S. Federal Reserve dot plot is a chart summarizing the Federal Open Market Committee’s (FOMC) outlook for the federal funds rate. Each dot represents the interest rate forecasted by one of the 12 members of the committee.

Volatility investing is a strategy that seeks to take advantage of sudden changes in the price of assets in markets where prices are changing rapidly, erratically, or by large degrees when compared with their historical averages. Investments in securities with volatile prices can carry both high potential rewards and high risk.

Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.

The Bloomberg Aggregate Bond Index broadly tracks performance of the U.S. investment-grade bond market, is composed of investment-grade government and corporate bonds, and is widely considered to be one of the best total bond market indices.

The Nasdaq Composite Index is a market capitalization-weighted index of more than 2,500 stocks listed on the Nasdaq stock exchange. It is a broad index heavily weighted toward the technology sector and composed of both domestic and international companies.

The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000^® Index, which represents approximately 7% of the total market capitalization of the Russell 3000^® Index.

The S&P SmallCap 600^® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

“Bloomberg^®” and the Bloomberg U.S. Aggregate Bond Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Raymond James Investment Management. Bloomberg is not affiliated with Raymond James Investment Management, and Bloomberg does not approve, endorse, review, or recommend Raymond James Investment Management’s Markets in Focus Weekly Insights. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to Markets in Focus Weekly Insights.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). ©LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. Russell^® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication.

M-539065 Exp. 8/29/2024