“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
Heightened volatility underscores the potential benefits of considering investments focused on diversification, selectivity, and long-term secular growth mega-trends.
A further broadening of earnings growth in the fourth quarter could help tie further market gains to earnings growth, as opposed to multiple expansion.
Small caps are more than just an interest rate story. Pay attention to sales growth and operating margins, not just financing costs.
We head into the peak of earnings season over the next two weeks with a strong fundamental economic backdrop and constructive market set-up, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
First, however, the market is sorting through the implications of the selloff that began early Monday, driven by the news around an open-source artificial intelligence (AI) model developed by a Chinese company.
The new AI system reportedly could deliver performance that matches leading U.S. AI companies, while using fewer of the specialized AI semiconductors that the market leaders rely on, making it far cheaper. The news raised questions about the long-term demand for the AI chips that have driven market gains over the past two years, as well as the business outlook for the companies that have ridden that wave. In response, AI-related stocks sank in early trading Monday.
To which Orton says, take a breath.
“Obviously, the market is scared,” he said. “The market always is going to over-react to these sorts of situations. It’s too soon to say how long the selloff lasts or how deep it goes.
“What I do know,” he said, “is that this speaks to the potential benefits of having diversified portfolios and not just having exposure to some of the tech winners, but considering whether to build out into other, more cyclical parts of this market that are levered to strengths of the U.S. economy that are not just predicated on the growth of artificial intelligence. When you think about reshoring and moving manufacturing back to this country, there are a lot of other themes that are secular in nature, have momentum, and are not dictated by artificial intelligence capital expenditures.”
Taking a broader view, the choppiness in December provided a healthy reset of sentiment and positioning, which became too extended following the U.S. election in November, Orton said. While the S&P 500 Index pulled back only about 4%, the average stock was down nearly 10% with 10-year U.S. Treasury yields up over 60 basis points to 4.8%.1
“I have long advocated for using downside opportunistically, and I believe investors were presented with an attractive opportunity this month to consider deploying some capital across both equities and fixed income,” he said. “The flurry of policy announcements and social media grenades are just getting started, and I expect them to move markets with expectations quite positive around tariffs, taxes, and the deregulatory agenda. This increased volatility highlights why I believe diversification and selectivity will be so important, and why I also believe it’s so important to think about leaning into the long-term secular growth mega-trends that are already firmly in place.”
These include the hundreds of billions of dollars of private capital being spent on artificial intelligence, but also on reshoring and diversifying supply chains and modernizing the power grid. These mega-trends, Orton believes, are bipartisan in nature and offer the new administration an opportunity to fuel the momentum that already exists.
“There are certainly near-term risks, including another potential backup in rates, renewed strength in the dollar, and surprising tariff policy,” he said. “But I do not think these risks ultimately will derail the strength of corporate earnings or meaningfully cut into margins, nor should they change the strength of the labor market and American consumer. Consequently, I believe investors should consider leveraging any downside opportunistically; think about potential ways to diversify across asset classes, market capitalizations, and geographies; and evaluate whether to lean into the mega-trends that I expect to drive growth in the long-term.”
Earnings growth is the key reason Orton has been so persistently optimistic on the market over the past two years. Earnings growth emerged from a recession in 2022, first for the mega-cap technology companies. Now it has started to broaden across sectors over the past few quarters. This increase in breadth continues to play out, and Orton expects that the results for the fourth quarter of 2024 could help sustain a further broadening. This could help tie further market gains to earnings growth, rather than to multiple expansion, he said. So far for the fourth quarter, the blended year-over-year earnings growth rate for the S&P 500 stands at 12.7% versus a consensus expectation of 11.8%. If that holds up, it would mark the highest earnings growth rate since the fourth quarter of 2021.
Not a bad start to the year...
2025 year-to-date S&P 500 sector returns through 1/24/2025
Source: Bloomberg, as of 1/24/25.
Margins also are holding strong despite concerns about inflation. This quarter marks the third consecutive quarter that the S&P 500 is reporting a net profit margin above 12%, and expectations are for margins to expand in 2025.
“I believe it will be critical to see margins remain strong, especially as we head into an uncertain environment with respect to tariffs,” Orton said. Going forward, he also plans to pay close attention to the outlook for sales growth against a backdrop of moderating nominal gross domestic product (GDP) and a strengthening dollar. Most mega-cap companies will report earnings over the next two weeks, and Orton said continued resiliency will be important as these stocks have been somewhat of a ballast for the market.
It’s tough to talk about earnings and mega-trends without also spending some time on capital expenditures (capex), particularly with respect to artificial intelligence (AI). Recent weeks have brought many reports on AI spending, including positive reinforcement last week from the largest chip manufacturer about continued capex within semiconductors. We also got a splashy multi-partner announcement of the Stargate Project, which promises $500 billion in spending over the next four years on AI infrastructure, though where that funding comes from is still to be announced. Upwards of $100 billion more in AI-related capex has been announced by players in the United States, China, and India. While many of these plans are still somewhat theoretical, Orton said all are directionally positive.
“We also can’t forget about the likelihood that we see a traditional infrastructure capex announcement over the coming months through Congress or the Trump administration,” he said. “All of this speaks to further support for U.S. exceptionalism and the opportunity for investing across the market. Not all companies will benefit, either, which is why I believe that selectivity is so important. But this kind of spending on a wide range of projects helps to keep earnings growing and people employed. And it’s a key reason why I find it difficult to turn bearish over the longer term as we live through periods of market consolidation.”
We’re returning to an environment, at least in the near term, where there’s an incessant focus on every announcement from President Trump or his administration. And that focus has caused, and will continue to cause, wobbles up and down in the market.
“I don’t believe long-term investors should react to every wobble, nor should they allow themselves to be overly worried or enthusiastic about any single headline,” Orton said. “We have to tune out the noise and assess how the direction and totality of these headlines will impact the outlook for earnings. The good news right now is that we’re heading into the peak of the earnings season, and that should help to offset any near-term noise. This week will be particularly important to see if the mega-cap complex will continue delivering on earnings.”
While the market has recovered nicely from its consolidation over the past month, there are still some near-term risks to monitor – the most significant of which concern tariffs. While some of the recent proclamations around tariffs on China have been encouraging, there hasn’t been as much encouraging news around Canada and Mexico. Ultimately, Orton said, we just don’t know what will be implemented and what the end result will be after negotiations. Therefore, we don’t know what the impacts will be. Orton does have concerns that investors may be celebrating too early with respect to recent headlines and the lack of formal tariff announcements to date. Given that President Trump largely leveraged tariffs as a negotiating tactic during his first term, Orton said investors may be underestimating the potential for more substantive tariffs in his second term. This is another reason why he likes thinking about leaning into key secular growth trends to guide investments. His ideas about areas to consider include:
Small caps are more than an interest rate story. The summer rally in small caps was partly based on the view that the U.S. Federal Reserve (Fed) would cut rates steadily to 3% or below, helping smaller companies that are more exposed to floating rates. The repricing of rate cut expectations led to a post-election selloff that Orton said missed the forest for the trees. The most important issue for smaller companies is not the cost of their debt finance, which represents about 2.3% of their sales, but instead the underlying strength of their businesses, measured by operating margins and sales growth. Rate expectations have risen because of expectations for continued economic growth, which translates into a return to sales growth for smaller companies. Interest costs are only about 2.3% of sales and are expected to remain stable as financing costs are more closely linked to shorter-term rates. If sales increase while financing costs remain relatively stable, there could be a supportive leverage effect to margins and earnings per share (EPS). “The market is totally missing this,” Orton said, “and I believe a constructive earnings season could provide a catalyst to finally see some sustainable small-cap outperformance over the broader market.”
Continue to think about secular growth mega-trends. Prior to the election, Orton counseled against positioning around the noise. Instead, he favored focusing on the long-term drivers of growth, particularly bipartisan priorities. Along with the capex beneficiaries from the AI buildout, Orton sees potential opportunities in areas exposed to reshoring trends, plus global aerospace and defense. Market dips can typically provide good entry points, and he expects to see these drivers of macroeconomic growth continue to translate into increasing EPS growth and steady or expanding margins. The key, he said, is not chasing these trades higher, but rather considering whether to leverage episodes of volatility. Earnings season will provide investors with an updated scorecard, he said, punishing the companies where reality has failed to live up to hype.
Stocks hit a series of all-time highs last week, helped by positive earnings, as bonds drifted sideways. Orton said further gains will rest on a big week of earnings reports as well as any surprises from this week’s meeting of the Federal Open Market Committee (FOMC). Fed Chair Jerome Powell likely will be asked about how the committee is looking at the recent easing in financial conditions with the more risk-on tone in the markets as well as Fed Governor Christopher Waller’s more dovish outlook and whether Powell himself has changed his own views. In the end, Orton expects the meeting results to be a non-event with Powell taking a “get out of there quick” approach, keeping comments short and not notably more dovish than December’s hawkish tone. On the earnings front, investors will hear from four of the biggest companies by market capitalization in the S&P 500.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Jan. 24, 2025.
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.
Diversification does not ensure a profit or guarantee against a loss.
Definitions
American exceptionalism is an idea centered on the notion that the United States is a unique and even superior nation as a result of historical, ideological, religious, and/or, in the context of finance, economic reasons. Proponents of American exceptionalism often expect or advocate for the United States to occupy or play a leading role in global affairs.
Backup refers to an unfavorable change in bond interest rates.
Ballast, in finance, can refer to characteristics, factors or trading strategies that mitigate volatility or provide stability to a security or group of securities.
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
Consolidation is a term used in technical analysis to describe when stocks reverse previous gains (or losses) to stay within well-defined trading levels.
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.
Dovish, hawkish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Centrists tend to occupy the middle of the continuum between tight (hawkish) and loose (dovish) monetary policy.
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.
Floating rate debt refers to debts with variable rates of interest, which are often tied to benchmark rates of interest such as U.S. Treasury note yields or the federal funds rate.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one quarter or one year. Nominal GDP reflects the value unadjusted for inflation.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
A megatrend is a widespread and long-term macroeconomic, technological, social, environmental, political, or other change that may develop slowly at first but that has a major, ongoing impact once it gets underway. Megatrends are distinct from smaller trends in business, economic, or other spheres of activity that have less far-reaching or enduring effects.
A multiple, sometimes referred to as the price multiple or earnings multiple, is a measure of a company’s value based on the ratio of its current share price to its earnings per share. This ratio is known as the price-to-earnings ratio, or P/E.
Multiple expansion occurs when a stock’s multiple rises, in some cases faster than the stock’s fundamental value. Multiple expansion creates arbitrage opportunities for investors who have bought the stock at the lower multiple value.
A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.
Operating margin measures how much profit a company makes on a dollar of sales after paying for production costs such as wages and raw materials, but before paying interest or tax. It is calculated by dividing a company’s operating income by its net sales.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
Risk-on sentiment is typically fueled by a strong growth environment in which good news supports a bullish outlook and investor expectations of favorable risk/reward ratios.
Reshoring describes an effort to bring manufacturing and other services back to the United States from overseas operations.
Indices
The S&P 500 Index measures changes 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 S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
The S&P 500® Industrials comprises those companies included in the S&P 500 that are classified as members of the GICS® industrials sector.
The S&P 500® Equal Weight Industrials Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® industrials sector.
The S&P 500® Communication Services comprises those companies included in the S&P 500 that are classified as members of the GICS® communication services sector.
The S&P 500® Equal Weight Communication Services Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® communication services sector.
The S&P 500® Energy comprises those companies included in the S&P 500 that are classified as members of the GICS® energy sector.
The S&P 500® Equal Weight Energy Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® energy sector.
The S&P 500® Materials comprises those companies included in the S&P 500 that are classified as members of the GICS® materials sector.
The S&P 500® Equal Weight Materials Index imposes equal weights on the
index constituents included in the S&P 500 that are classified in the GICS® materials sector.
The S&P 500® Financials comprises those companies
The S&P 500® Equal Weight Financials Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® financials sector.
The S&P 500® Utilities comprises those companies included in the S&P 500 that are classified as members of the GICS® utilities sector.
The S&P 500® Equal Weight Utilities Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® utilities sector.
The S&P 500® Health Care Index comprises those companies included in the S&P 500 that are classified as members of the GICS® health care sector.
The S&P 500® Equal Weight Index Health Care Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® health care sector.
The S&P 500® Consumer Discretionary comprises those companies included
in the S&P 500 that are classified as members of the GICS® consumer discretionary sector.
The S&P 500® Equal Weight Consumer Discretionary Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® consumer discretionary sector.
The S&P 500® Real Estate comprises those companies included in the S&P 500 that are classified as members of the GICS® Real Estate sector.
The S&P 500® Equal Weight Real Estate Index is designed to impose equal weights on the index constituents included in the S&P 500 that are classified in the GICS® real estate sector, excluding mortgage REITs.
The S&P 500® Information Technology Index comprises those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.
The S&P 500® Equal Weight Information Technology Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® information technology sector.
The S&P 500® Consumer Staples comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer staples sector.
The S&P 500® Equal Weight Consumer Staples Index imposes equal weights on the index constituents included in the S&P 500 that are classified in the GICS® consumer staples sector.
M-680815 Exp. 5/27/2025
Earnings season could bring more evidence of a strong fundamental business and economic backdrop for equities.
Watch for increased clarity from the new Trump administration on the potential benefits of policy changes, but don’t expect moves on tariffs right away.
Areas worth watching include cyclicals (particularly financials and energy), select portfolio diversification opportunities abroad, and small caps.
It’s been a strange month. Good news has been bad news for the path of interest rates and the stock market: Strong economic data amid sticky inflation has challenged the case for further rate cuts, and many investors have been on edge about the inflationary impact of policies under Trump 2.0.
But that could be coming to an end.
“The sharp backup in rates has been painful, but it also looks like the worst may have passed,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “Now that we’re entering earnings season, I anticipate that not all good news will be bad anymore. To the contrary, I expect a reminder that there is still quite a lot going right for the market.”
Strong results from financial companies last week highlighted the case for U.S. exceptionalism to continue, Orton said, while upbeat management commentary provided a positive read-through to the state of the U.S. consumer as well as the potential benefits of deregulatory policy.1
This week will not only bring more earnings updates from financials and key consumer companies, but also some clarity about the new Trump administration’s key priorities. Orton expects the clarity from the initial executive orders to provide some additional relief to the market: The focus so far has been on all of the negatives that could come from tariffs or immigration policy rather than the totality of policy and potential positives.
“Earnings season is giving us a reminder of these potential positives and that, so far, companies have largely been immune to the rise in rates,” Orton said. “I have been expecting a higher-volatility bull market, and I believe that we’ll continue to see sharp moves across asset classes as investors process incoming information. But the positive fundamental backdrop continues to look solidly in place. As a result, I believe investors should consider using downside opportunistically.”
The fourth-quarter earnings season is off to a strong start
FactSet S&P 500 sector earnings per share (EPS) growth: current estimates vs. pre-season estimates
Source: FactSet, as of 1/17/2025.
The average stock is oversold, and Orton believes changes to policy amid a strong domestic economy and improving global backdrop could benefit many cyclical pockets of the market. He believes diversification could be a key to success across asset classes, sectors, market capitalizations, and geographies.
The selloff reached a crescendo following the strong payroll report for December, but Orton said it seems that since then the market learned that the world isn’t falling apart and found some stability. While the rise in rates and the dollar have been strong headwinds, he thinks the worst is now behind. The average stock was showing deeply oversold conditions, with fewer than 20% of S&P 500 Index constituents trading above their 50-day moving averages. Now, Semiconductor companies and banks have regained strength after strong earnings results.
“In general, I feel like the market has been uniformly focused on the potential problems from the new Trump administration rather than taking a more balanced view,” he said. Tariffs will certainly be a disruption — and could yet lead to another rally in the dollar — but Orton believes it’s unlikely that they will have a significant long-term negative impact on growth or inflation.
“Let’s also not forget the other offsetting benefits that could come from deregulation and clarity with respect to tax cut extensions,” he said. “As we’ve seen before, I expect that the bark is probably going to be worse than the bite. That is not priced into the market right now, and as we get further policy clarity over the next few weeks, I expect there will be scope for the market to continue to move higher, especially if earnings from the tech giants deliver.”
Policy will be the key focus this week, and Orton said there is scope for a post-Consumer Price Index relief rally depending on the specifics of Trump’s first executive orders. Market participants have a good idea of what Trump wants to accomplish with respect to tariffs, deregulation, foreign policy, and immigration, Orton said, and the key will be how he approaches these goals. Deregulation can set a very positive tone in the near term and give smaller companies additional scope to rally as they stand to be among the biggest beneficiaries. Immigration policy also has the scope to lead to some near-term volatility. But Orton said recent examples of extreme policy like we’ve seen in Florida — which requires larger employers to check workers’ immigration status and mandates hospitals that accept Medicaid to ask emergency room patients about their immigration status — haven’t had the negative impact on labor that many were expecting.
At the end of the day, Orton said, we’ve had a healthy reset of sentiment and positioning while the strong fundamental backdrop has remained intact. Rate volatility likely remains elevated, though he sees risks for yields as two-sided right now, which can help the market to build a base for further gains. Strong labor market data and expectations for higher long-term inflation are pushing estimates for the U.S. Federal Reserve’s neutral rate of interest higher, but Orton said they are balanced by some recent relief on the inflation front and future policy clarity.
“I hope this allows earnings to stand out as the main driver of the market — and we’re off to a very good start with the big banks,” he said.
Better balance across earnings results also could provide an upside catalyst for the market as the average stock still doesn’t look too expensive from a valuation perspective, he said. While the Magnificent Seven are expected to continue to show strong earnings of more than 17% over the next four quarters, the other 493 companies in the S&P 500 are expected to report year-over-year earnings growth of more than 9% over this same period, continuing to build on their strong momentum from the past few quarters. This is expected to lead to double-digit earnings growth for the S&P 500 in all four quarters of 2025 — and Orton expects 13% earnings per share (EPS) growth in 2025 — along with strong net profit margins.
Orton believes that increasing earnings strength across more sectors and industries could lead to a better balance between growth and value – and between the mega-caps and everyone else.
“Following the recent selloff, I think there are some interesting opportunities for investors to consider, but I wouldn’t be too aggressive yet given uncertainty with respect to the path of interest rates and the dollar in the short term.” Here are a few areas that he believes stand out right now:
Cyclicality, especially financials and energy. Orton has been highlighting financials for the past few months given their attractive valuations, rising earnings, and the potential to benefit from deregulatory policy under the new Trump administration. He favors big banks and capital market companies within financials right now, especially if we see a more pronounced level of deal activity going forward. Energy also has stood out lately, especially natural gas. Big oil names have risen on expectations for a favorable regulatory environment as well as re-accelerating earnings momentum. However, Orton notes that they have lagged their historical beta to crude oil, leaving potential upside on the table, especially if results come in better than expected.
International diversification. The underperformance of global equities over the past decade has been extreme, and Orton does not argue that global stocks could outperform the United States in aggregate. Moreover, he firmly believes that investors should consider thinking about maintaining a core overweight to the United States given its strong and continuing fundamental backdrop that could even improve. However, he believes earnings overseas could inflect higher, just as we saw with the average U.S. stock a few quarters ago. From a portfolio construction standpoint, he thinks there are diversification benefits to consider that include an allocation to non-U.S. equities, especially given the elevated level of rate volatility. In many developed and emerging markets, he expects to see continued policy easing, lower-valued currencies helping export sectors, and favorably priced equity valuations. The surge in European luxury goods last week highlighted the potential opportunities that exist for selective investors, he said.
Small caps. Small-cap equities held key levels of resistance on the downside. Now this earnings season is expected to showcase the Russell 2000® Index’s first quarter of positive year-over-year EPS growth in years, and 2025 projections forecast the index posting EPS growth that outpaces the S&P 500. Orton also thinks the market is much too negative right now about the impact of rising interest rates on small caps, especially higher-quality small caps. While rates have gone up, he said, actual funding costs haven’t followed as they are tied to the Secured Overnight Financing Rate (SOFR) and not moves in the 10-year U.S. Treasury yield. Funding costs came down 100 basis points as the Fed cut rates. Also, he said, a steeper yield curve tends to benefit small caps. Flows remain anemic, but Orton said it wouldn’t take much capital to get these companies going: the Russell 2000 is less than 6% of the Russell 3000® Index, and the five biggest stocks by market capitalization in the S&P 500 are nearly five times the size of the entire Russell 2000. Small caps remain cheap on a relative basis, too, with the five largest stocks by market cap in the S&P 500 trading at about 10x their price-to-sales ratios versus a comparable price/sales ratio of about 2x for the Russell 2000.
It’s all about Trump and earnings this week. Trump’s flurry of executive orders will set the tone on what we can expect from his administration in a wide range of policy areas, particularly immigration and energy. However, we’re not likely to see tariffs just yet, and any further indications of coming tariff policies will likely move the markets one way or another. Earnings season also heats up in the U.S. with results from financials, some key consumer companies, and airlines. This should offer another good read into the state of the U.S. consumer across different levels of income, Orton said.
Outside of the United States, the World Economic Forum in Davos brings various heads of state, central bankers, and business leaders together for five days of meetings. The Bank of Japan holds a key meeting on Friday with a strongly expected interest-rate hike. Topping the list of data releases to watch are S&P Global Flash PMI™ (Purchasing Managers’ Index) reports for the United States, United Kingdom, Eurozone, Germany, France, India, and Japan on Friday. UK jobs data will also garner interest after the latest readings of inflation and economic growth surprised to the downside.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Jan. 17, 2025.
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
American exceptionalism is an idea centered on the notion that the United States is a unique and even superior nation as a result of historical, ideological, religious, and/or, in the context of finance, economic reasons. Proponents of American exceptionalism often expect or advocate for the United States to occupy or play a leading role in global affairs.
Backup refers to an unfavorable change in bond interest rates.
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Beta is a measure of the volatility or systemic risk of a security, group of securities, or portfolio compared with another security, group of securities, portfolio, or the market as a whole.
The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.
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.
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.
Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset, sector, or index. 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.
Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.
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.
An inflection in an investment trend marks a sudden change in the direction and rate of change of investor behavior regarding particular securities or areas of the markets. Inflections can lead to either positive or negative change.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 31, 2024. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.
A net profit margin, often shortened to net margin, measures how much net income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.
The neutral rate of interest of the U.S. Federal Reserve (Fed), often referred to as r-star or the natural rate of interest, refers to the short-term interest rate at which the economy would be at full employment with stable inflation. In other words, it is the interest rate at which Fed policy neither pushes the economy toward expansion or contraction.
Oversold is a term used to describe a security or group of securities believed to be trading at a level below its or their intrinsic or fair value.
Overweight describes a portfolio position in an industry sector or some other category that is greater than the corresponding weight level in a benchmark portfolio.
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 price to sales ratio (P/S) is calculated by dividing a company’s market capitalization by the revenue in the most recent year.
A resistance level represents a price point that an asset has had trouble moving beyond in a period of time being considered.
The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. The Federal Reserve Bank of New York publishes the SOFR on its website at about 8 a.m. each business day.
S&P Global Flash PMI™ (Purchasing Managers’ Index) reports are produced for various countries by by S&P Global and are based on original survey data collected from companies based in the manufacturing and service sectors. The flash esti¬mates is based on around 85% of total PMI survey responses each month and are designed to provide an accurate advance indication of the final PMI data.
Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing or more variable data.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. A steepening yield curve results from a widening in the difference between short- and long-term interest rates. A steepening curve often reflects an expectation of stronger economic activity, rising inflation, and rising interest rates.
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 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 Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 98% of the total market capitalization of all U.S. incorporated equity securities.
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-673945 Exp. 5/21/2025
Last week’s hotter than expected payroll report called into question the path forward for interest rates, fueling market volatility, with the potential for more on the way.
Still, earnings season is expected to bring another strong quarter of earnings per share growth for the S&P 500 Index.
In this environment, areas to consider include cyclicals, small caps, and beneficiaries of the continuing growth of artificial intelligence.
Equities were broadly lower last week with the S&P 500 Index falling 1.94% for its second red week in a row, and its fourth out of the last five.1 The Russell 2000® Index was down 3.49% and is now notably below where it was trading before the election. Higher rates and a stronger dollar have continued to weigh on equities as the 10-year U.S. Treasury yield is all the way up to 4.75%, approximately 20 basis points (bps) higher than where it started this year, and about 110 bps higher than when the U.S. Federal Reserve (Fed) first cut the federal funds rate by 50 bps in September. Meanwhile the U.S. Dollar Index has been higher in 14 of the last 15 weeks.
“This is what a higher-volatility bull market looks like, and I believe the reaction to last week’s payroll report is yet another example of what to expect going forward,” said Joey Del Guercio, Research Associate for Market Strategy at Raymond James Investment Management. “It’s no secret that the market’s been running hot, but no part of me thinks this is the end of the bull market.”
That’s because the fundamental backdrop for equities remains constructive, and Del Guercio said he thinks the S&P 500 drawing down nearly 5% is a necessary reset that sets itself up nicely heading into earnings season and the inauguration.
The big story of last week’s shortened trading week was the December payroll report from the U.S. Bureau of Labor Statistics. December nonfarm payrolls came in far hotter than expected:
Up 256,000 month over month versus an estimated 165,000;
The unemployment rate fell by 0.1% to 4.1% (versus the consensus expectation of 4.2%); and
Average hourly earnings were in-line with expectations at 0.3% month over month.
“This was another instance of the data being so good that it’s bad because it calls into question the path forward for interest rates,” Del Guercio said. As one would expect, the futures-implied fed funds rate path shifted meaningfully more hawkish following the report. The day before the jobs report, there was one full cut priced in by June and two priced in by September. After the report, there was just one cut priced in by September. From a very big picture, the jobs report is good news: we have a solid labor market that people were worried about falling apart just a few months ago. Accordingly, the Fed won’t be able to justify further easing based on a weakening labor market. That puts inflation back in the driver’s seat and makes Wednesday’s December Consumer Price Index (CPI) report that much more important in gauging the path forward for interest rates.
The S&P 500 is in its third biggest drawdown in a year ... just 4.3%
S&P 500 drawdowns since 2021
Source: Bloomberg, as of 1/10/2025.
“I don’t think we see good news leading to selloffs for too much longer, since the market is now pricing in an amply hawkish Fed,” Del Guercio said. Despite all the macroeconomic noise, he said there are two main catalysts to look forward to in the coming weeks.
First, Donald Trump will be inaugurated as the 47th U.S. president on Jan. 20. This should provide some much-needed certainty to the market, Del Guercio said. The policy uncertainty since the election has had traders (and the Fed) guessing about the implications of potential policy. In one week, the guessing games will be over, and we’ll begin to get clarity on what Trump’s actual policies look like, he said.
Until then, investors can look forward to the banks kicking off 2024’s fourth-quarter earnings season in earnest this week. Currently, the S&P 500 Index is expected to post 11.7% year-over-year (y/y) earnings growth in the quarter, accelerating meaningfully from the third quarter’s growth of 5.9%. The expected 11.7% would mark the index’s strongest growth since the fourth quarter of 2021 (which had the now-absent benefit of comparables from the depths of the COVID-19 pandemic), and Del Guercio said he believes there’s certainly scope for the index to beat this. The S&P 500 has beaten its pre-season earnings per share (EPS) estimates in all of the last seven quarters. In fact, he noted, if you apply the average improvement in earnings growth during the earnings season to the pre-season estimate, fourth-quarter EPS growth could come in closer to 14%.
This earnings season also could be beneficial for breadth, he said, as seven of the S&P 500’s 11 sectors are expected to post positive growth. Six of those seven are expected to post double-digit earnings growth, and five of the seven are expected to post growth outpacing the broader index. Financials are expected to post the highest y/y growth of +39.5%, led by banks (+186%).
“Earnings season should bring some much-needed sanity back into the market as we all refocus back on the fundamentals,” Del Guercio said.
S&P 500 expected to post highest earnings growth in three years
FactSet end-of-quarter estimates versus actual earnings growth
Source: FactSet, as of 1/10/2025.
With waning uncertainty and earnings on the horizon, Del Guercio said investors have reason to feel optimistic about the market getting back on its feet. Still, he continues to expect elevated volatility, mainly centered around economic data releases and what they indicate about the path forward for interest rates. There’s sure to be heighted volatility related to headlines going forward, too. Del Guercio said last week’s Greenland/Canada/Panama triple whammy is a reminder of what the new status quo is going to be. He favors focusing on the fundamentals, thinking about building diversification to help position investment portfolios from heightened volatility, and considering the potential of leaning into long-term secular themes. He believes areas of potential opportunity include:
Cyclicality. Economic growth continues to hold up better than expected, and the next administration’s pro-growth agenda is expected to be an added tailwind for this economically sensitive cohort, Del Guercio said. In addition to the focus on financials’ earnings growth, he said this week’s earnings reports could provide insight into the capital markets, where the expectation is broadly for increased mergers and acquisitions (M&A) and initial public offering (IPO) activity inspired by a new Federal Trade Commission agenda underscored by deregulation. He said industrials remain a sector to think about considering its exposure to broad economic growth as well as to defense, capital expenditure (capex) spending fueled by the growth of artificial intelligence, and U.S. manufacturing and construction.
Small caps. Despite continued underperformance, Del Guercio believes the case remains for small caps in 2025. This earnings season is expected to showcase the Russell 2000’s first quarter of positive y/y EPS growth for the first time in years, and 2025 is projected to show the index post EPS growth outpacing the S&P 500. It wouldn’t take much capital to get these companies going, he said: the Russell 2000 is less than 6% of the Russell 3000® Index, and the five largest stocks by market capitalization in the S&P 500 are nearly five times the size of the entire Russell 2000. Small caps appear to be attractively valued on a relative basis, too, with the five largest stocks by market cap in the S&P 500 trading at about 10x their price/sales ratios versus the Russell 2000’s ratio of approximately 2x price to sales.
AI 2.0. Last week, the world’s biggest semiconductor foundry reported fourth-quarter revenue growth that came in ahead of estimates at 39% y/y. The proliferation of artificial intelligence does not look to be slowing down, Del Guercio said. Where the last two years have largely seen the AI enablers soar, Del Guercio expects that the future will see AI winners expand to other sectors and industries. He continues to like the AI capex winners related to data center construction/engineering, coolers/servicers, and energy generators/distributors. “It already seems like we’re going to be hearing plenty about ‘agentic AI’ this year, which I believe means it’s time to keep an eye out for the true AI software winners going forward,” he said.
Fourth-quarter earnings kicks off in earnest this week with the major banks. Other noteworthy earnings releases include a semiconductor manufacturer and a health insurance company, both on Thursday. The National Federation of Independent Business’s Small Business Optimism Index and the December Producer Price Index come out on Tuesday; December’s CPI on Wednesday; December retail sales on Thursday; and December housing starts and building permits on Friday.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Jan. 10, 2025.
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
Agentic artificial intelligence (AI) is a type of advanced AI that can act autonomously, make adaptations as it goes, and address multi-step tasks based on context and objectives with limited human supervision.
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
Capital expenditures, or capex, are monies used by a company to buy, improve, or maintain physical assets such as real estate, facilities, technology, or equipment, and may include new projects or investments.
Comparables, often shortened to comps, carries different meanings depending on the industry and context, but generally entails a comparison of financial metrics – often for two different time periods – or other factors to quantify performance or determine valuation.
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.
The U.S. Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.
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.
A drawdown is a decline in the returns of a security or group of securities, as measured over a period from the peak of returns to their trough.
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 funds rate is the target interest rate set by the Federal Open Market Committee of the U.S. Federal Reserve. The target is the Fed’s suggested rate for commercial banks to borrow and lend their excess reserves to each other overnight.
The futures-implied federal funds rate offers a projection of the federal funds rate as reflected by futures contracts based on the fed funds rate.
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.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
The National Federation of Independent Business’s Small Business Optimism Index surveys small and independent business owners on 10 equally weighted and seasonally adjusted variables, including their hiring, investment, and inventory plans, as well as on their economic expectations, assessment of the state of the economy, labor market, credit conditions, and earnings trends. The monthly change of each variable contributes proportionally to the overall monthly change in the 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 price to sales ratio (P/S) is calculated by dividing a company’s market capitalization by the revenue in the most recent year.
The Producer Price Index (PPI), published monthly by the U.S. Bureau of Labor Statistics, measures the average change over time in the selling prices received by domestic producers for their output.
Secular trends are large-scale and ongoing changes in economies and societies that have the potential to drive broad and lasting economic, technological, social or other kinds of changes.
Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.
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 U.S. Dollar Index is a measure of the value of the U.S. dollar relative to the value of a basket of currencies from most of the U.S.’s most significant trading partners.
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.
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-667984 Exp. 5/13/2025
2025 is setting up to include more pronounced bouts of market volatility.
That, however, does not change the solid fundamentals or range of tailwinds that this bull market is grounded in.
Matt Orton, CFA believes that heightened volatility makes a strong argument for considering the benefits of a more diversified portfolio, with potential opportunities in a few key areas.
Now that the market has closed the chapter on 2024, it starts the new year with elevated caution following the second consecutive year of 20%-plus gains for the S&P 500 Index.1
Despite a challenging December, the S&P 500 still returned 25% last year, driven by factors that include:
A continued run in technology names tied to artificial intelligence,
Easing financial conditions and the start of the interest rate cutting cycle,
Continued earnings growth and strong profit margins, and
Economic resiliency.
Looking forward, however, many of these drivers seem to be well priced into the market, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. Some are even turning into headwinds as the strength of the market and the resiliency of the economy force the U.S. Federal Reserve (Fed) to slow or even pause rate cuts. The backup in rates and changing Fed narrative have fueled recent market weakness and could pose a serious challenge to future gains if the 10-year U.S. Treasury yield continues to push toward 5%, he said.
“While these are very real headwinds — we also can’t forget about the unknowns around future policy and geopolitics — I do not think they derail the long-term bull market, and I continue to believe that the ultimate path for the market is higher,” Orton said.
One of Orton’s key expectations in 2025 is for more pronounced periods of volatility moving forward, and he sees December as a preview of that.
“I believe this higher-volatility bull market is a strong argument for better diversification as I expect the rising tide won’t lift all boats,” he said. “But I do think it could provide investors who are considering diversification with better entry points to make potential changes to their portfolios. Rather than fear the volatility, we should embrace it. I suggest investors take a hard look at their portfolios and consider preparing a shopping list so that they can be ready to use downside opportunistically.”
A higher-volatility bull market is nothing new. In fact, we don’t have to go too far back in history to draw a few useful lessons for 2025. During President-elect Donald Trump’s first term, we saw a period of exuberance starting at his inauguration all the way through the passing of the Tax Cuts and Jobs Act in December 2017. The risk environment became self-fulfilling with tighter credit spreads and lower volatility feeding risk-taking behavior. This culminated in the S&P 500 hitting its most overbought levels in 50 years in January 2018.
Orton said that feels pretty similar to the risk environment for most of 2024, especially in November. The exuberance unwound in 2018, starting first with “Volmageddon,”2 a sharp spike in volatility in February 2018, then elevated volatility around tariffs and trade, and finally a 20% drawdown due to a surprisingly hawkish Federal Open Market Committee.
“By drawing these parallels, I’m not suggesting that we’ll see a 20% Fed-induced crash,” Orton said. “I do, however, think that there are increased risks of disorderly drawdowns like we saw throughout 2018 as we unwind similar levels of excess. We’ve already seen a few volatility events in the second half of 2024, and I expect that we’ll see that pattern of episodic volatility continue and increase in 2025. And, just like we saw for most of 2018, I expect that the market will recover from each event and push higher.”
Why does Orton believe that the path is ultimately higher? That largely rests on the fact that the bull market is grounded in solid fundamentals with a myriad of tailwinds behind it, he said. While December was quite negative for market breadth, he said it has slowly been expanding under the surface, catalyzed by strong and broadening corporate earnings and resilient margins. The S&P 500’s earnings growth is expected to accelerate in 2025 with the S&P 493 expected to contribute more to headline growth than the Magnificent Seven. Policy is stimulative and is expected to get more stimulative in the coming years considering Trump’s pro-growth agenda and expected plans for deregulation, he said.
The good news regarding the Fed is that the market has rapidly repriced interest rate cut expectations, with the consensus now estimating between one and two cuts in 2025. While some stickier inflation reports could cause a further spike in interest rates, Orton doesn’t think such moves are sustainable and could present opportunities for long-term investors.
Earnings growth expected to accelerate broadly in the fourth quarter of 2024
FactSet S&P 500 quarterly year-over-year earnings growth estimates
Source: FactSet, as of 1/3/2025.
This will be an important week for the market given some critically important data releases and where the market goes from a technical crossroads, Orton said. The sideways price action and bounce on Friday brought short-term technical indicators out of deeply oversold territory while the market is no longer overbought on a longer-term perspective, he said. The percentage of S&P 500 components trading above their 10- and 50-day moving averages rebounded last week, with the percentages rising to 50.89% and 24.10%, respectively. This is the first time in a month that more than half of the S&P 500’s components have been trading above their 10-day moving averages. That is encouraging, but Orton believes the market needs to see more follow-through this week or it risks a prolonged period of malaise or even more downside.
A client recently asked Orton if he had an acronym that captures the key facets of his investment outlook for 2025.
“The question took me by surprise,” he said, “and I didn’t think there really was a single word that could capture both the diverse risks investors face as well as the attractive areas of opportunity. But as I thought about the ‘known unknowns’ we face in 2025 and the vast range of outcomes, I realized the word was right in front of me.”
Think V.A.S.T. — as in:
Volatility — Be prepared for an uptick in volatility and an increased risk of disorderly selloffs like we saw over the summer in the unwinding of the yen carry trade or during Volmageddon in 2018. This doesn’t mean there’s a need to be overly defensive or to reduce risk, Orton said. Quite the opposite. He believes the fundamentals underpinning this bull market remain firmly in place, and consequently his playbook favors having a properly diversified portfolio across asset classes, geographies, and market capitalizations.
Artificial intelligence — Orton doesn’t think the AI trade is slowing down. To him, that suggests the importance of thinking about leaning into the megatrends that he believes are likely to lead earnings growth next year and beyond. In addition to the hyperscalers, he said there are so many other opportunities for 2025 that are levered to the AI trade. He calls this the “AI 2.0” basket of companies that are enabling the AI revolution, including those focused on providing power, cooling solutions, and construction and engineering capabilities for the growth of data centers and semiconductor fabrication plants.
Small caps — December was one of the worst months for small caps in history, but Orton believes that only creates a better entry point for investors who thought they missed the trade following the election in November. He considers both small and mid caps to be attractive on a relative basis and generally under-owned in investor portfolios. Funding costs at small-cap companies have already come down given the 100 basis points of rate cuts that have already occurred, he said.
Trillion-dollar club — The success of the largest companies in the market will be important for overall index returns, Orton said. He continues to expect that we’ll see more broadening, but that doesn’t mean many of these names can’t do well. He thinks the business models of these companies are remarkably strong, and the companies generally screen as very high quality. Better diversifying a portfolio doesn’t mean rotating out of mega-caps, he said. Rather, it means being conscientious about how large a position they occupy in your portfolio and thinking about taking steps to have exposure to a broader basket of assets.
S&P 500 breadth is back around July lows
Source: Bloomberg, as of 1/3/2025.
A barrage of key economic data this week culminates Friday with the U.S. Bureau of Labor Statistics’ payroll report for December. We also get durable goods orders and Services ISM® Report on Business® data throughout the week. The minutes from the Federal Reserve’s mid-December meeting are released on Wednesday, and at least six Fed policymakers are scheduled to speak publicly this week.
Overseas, traders will be watching China’s Consumer Price Index and Industrial Sector Producer Price Index as well as aggregate financing data for signs that recent stimulus measures are starting to have the desired impact on the economy. Japanese wage growth and Australian inflation figures are also due.
Washington will also remain in focus. Now that the House speaker election is past, the market will look for any updates with respect to the pace and magnitude of policy changes following Trump’s inauguration on Jan. 20.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Jan. 3, 2025.
2 Volmaggedon is a combination of the words “volatility” and “Armageddon.”
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
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean. Market breadth is said to narrow when a smaller number of more extreme outliers drive the mean of an index further from its median.
A carry trade involves borrowing money in countries where interest rates are low and using the funds to make investments in countries with high interest rates. An unwinding in a carry trade refers to the rush that takes place when many investors leave trade all at once.
The China Consumer Price Index (CPI), released monthly by the National Bureau of Statistics of China, measures changes over time in prices of goods and services in eight categories and 268 basic divisions covering consumption by urban and rural residents, including food; tobacco and liquor; clothing; residential costs; household articles and services; transportation and communication; education, culture, and recreation; healthcare; and other articles and services.
The China Industrial Sector Producer Price Index (PPI) is released monthly by the National Bureau of Statistics of China and reflects the trend and level of prices change when the products are sold for the first time. The survey of industrial producers covers the prices of industrial products in 40 major industrial categories and more than 1,300 basic categories.
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.
A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.
Credit spread tightening refers to the contraction of credit spreads in response to changes in economic conditions that cause a decline in credit risk.
Defensive investment strategies are characterized by rebalancing the investment portfolio regularly to maintain an intended asset allocation. They also typically entail investing in high-quality, short-maturity bonds and blue-chip stocks, diversifying across sectors and countries, and holding cash and cash equivalents in down markets.
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.
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.
Headline measures of economic activity such as price trends or gross domestic product include all economic activity and are often referred to as nominal measures.
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.
Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale
Known unknowns refer to identified areas of potential risk with uncertainty surrounding the timing, scope of impact, or path of development for those risks.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
A megatrend is a widespread and long-term macroeconomic, technological, social, environmental, political, or other change that may develop slowly at first but that has a major, ongoing impact once it gets underway. Megatrends are distinct from smaller trends in business, economic, or other spheres of activity that have less far-reaching or enduring effects.
The moving average (MA) is a technical analysis tool that smooths out stock price data by creating a constantly updated average price, often over a specified period of time, such as 15, 30, 50, 100, or 200 days.
Overbought is a term used to describe a security or group of securities believed to be trading at a level above its or their intrinsic or fair value.
Oversold is a term used to describe a security or group of securities believed to be trading at a level below its or their intrinsic or fair value.
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.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
Quality investing is a strategy that seeks to invest in companies with low debt, stable earnings, consistent asset growth, and strong corporate governance, as reflected in financial metrics such as ratios of return to equity and debt to equity, as well as to earnings variability.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
The S&P 493 refers to the constituents of the S&P 500 Index outside of the seven largest companies by market capitalization.
The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.
Sticky is a term used to describe measured data that is slow to change, in contrast to faster-changing or more variable data.
Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.
The Tax Cuts and Jobs Act (TCJA) of 2017 was a sweeping revision of the U.S. tax code that reduced taxes for individuals and businesses. The changes for businesses created a single flat corporate tax rate of 21% and also affected deductions, depreciation, expensing, tax credits, and other tax items that affect businesses. The corporate tax cut is permanent. The individual tax cuts are scheduled to expire in 2025.
Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.
Unwinding describes the process of closing out what is often a large or complicated trading position.
Volmaggedon is a portmanteau of the words “volatility” and “Armageddon.” It is used to describe a period in February 2018 when market volatility sharply spiked, triggering strong market reactions.
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 S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.
M-663176 Exp. 5/6/2025
