“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
The probability of the United States entering a recession is falling, but the probability of inflation reaccelerating is rising.
The next two weeks will be highly consequential, with many key earnings releases, forthcoming economic data, the presidential election, and the Federal Open Market Committee meeting on Nov. 7.
Themes to consider in this environment: Cyclicality. Small caps. India.
The next two weeks are effectively the Super Bowl of investing. Key earnings reports and data releases will lead right into the U.S. election, with the next Federal Open Market Committee meeting soon after.
“Buckle up,” said Joey Del Guercio, Market Strategy Research Associate at Raymond James Investment Management. “I believe volatility is likely to increase.”
In the meantime, markets are in a bit of limbo. The S&P 500 Index declined by 0.96% last week, snapping its streak of six consecutive weekly gains while the tech-heavy Nasdaq Composite Index eked out a 0.16% gain for its seventh weekly gain in a row on the back of mega-cap technology stocks.1 The expansion of breadth stalled: The Magnificent Seven rose 3.49%, while the S&P 500® Equal Weight Index and the S&P 493, which is the rest of the S&P 500 minus the Magnificent Seven, each declined roughly 2%, and the Russell 2000® Index fell 2.99%. The soft-landing narrative continues to materialize as the consensus base case, but questions are reigniting about the path for interest rate cuts going forward.
Somewhat counterintuitively, interest rates are higher now than they were when the U.S. Federal Reserve (Fed) cut the federal funds rate on Sept. 18. The 10-year U.S. Treasury yield went from 3.65% the day before the 50-basis point cut to 4.24% now, an increase of 59 basis points.
So why is that?
“Essentially, the probability of the United States entering a recession is fading, but the probability of inflation reaccelerating is increasing,” Del Guercio said. The Fed has a dual mandate — maximum employment and stable prices — and interest rates were originally raised this cycle to squash the inflation induced by the COVID-19 pandemic and zero interest-rate policy (ZIRP). So, the soft-landing scenario is the one in which the Fed brings down inflation to its 2% target via restrictive monetary policy (higher rates) without sputtering economic growth enough to send the economy into a recession. Now, with economic data continuing to surprise to the upside, investors are beginning to question if the Fed really needs to cut rates and stimulate more growth leading to more inflation down the line. Last week, the S&P Global Flash U.S. Composite PMI® purchasing manager indexes came in ahead of estimates while initial jobless claims came in at the lowest level in a month, corroborating that growth and the labor market are holding up better than expected. There’s also some political noise around inflation’s stickiness and potential reignition.
“As former President Donald Trump’s odds of winning continue to rise, so does the odds of his policies being enacted,” Del Guercio said. “Of those, tariffs, tax cuts, and the curbing of immigration are inherently inflationary.”
Additionally, the growing U.S. deficit is another argument for inflation down the road with the United States now paying more on its interest payments annually than it does on defense.
“Inflation might be the easiest way out,” Del Guercio said. “That said, I caution against being a deficit-doomer considering that it hasn’t paid well to date to wait on the sidelines for something to happen. Higher rates aren’t the end of the world, and equities certainly haven’t needed rates to go lower as performance has been blistering. I believe interest rate expectations can continue to adjust toward a higher for longer future without it being detrimental to equities broadly.”
Last week was the first week of the two-week peak in the S&P 500’s third-quarter earnings season, and results continued to be broadly positive. Roughly 37% of the index has reported to date, and of those who have reported, 75% have posted a positive earnings per share (EPS) surprise while 59% have reported a positive revenue surprise. While expectations remain for this quarter to be the S&P 500’s slowest quarter of EPS growth since the second quarter of 2022, it will be the index’s fifth straight quarter of EPS growth and expectations remain for an earnings reacceleration featuring double-digit year-over-year earnings growth in each of 2025’s quarters.
The Great Rotation remains on solid footing
Performance of S&P 500 sectors vs. select indices, 7/10/24 to 10/25/24
Source: Bloomberg, as of 10/25/2024.
A major electric vehicle company kicked off the Magnificent Seven’s earnings last week, smashing estimates, rising impressively following the report, and giving investors more reason for optimism heading into this week. Now most eyes will be on the five Magnificent Seven constituents who report earnings this week. While the Magnificent Seven are expected to post decelerating earnings growth, Del Guercio said it’s going from extraordinarily robust to still robust. Consensus expectations are currently for the S&P 500 to grow EPS by about 3.4% year over year in the third quarter, 98% of which is expected to come from the Magnificent Seven. The leading designer of advanced semiconductors used in artificial intelligence (AI) alone is expected to be 46% of the index’s earnings growth, and with its Magnificent Seven peers making up a majority of its revenues, investors may pay extra attention to the hyperscalers’ capital expenditures (capex) guidance and commentary concerning their building out of the AI ecosystem.
“I’d be very hesitant to recommend trading against this elite cohort,” Del Guercio said, “especially as it heads into earnings with trailing underperformance.”
With the next two weeks comes an enormous amount of new information that Del Guercio expects to shape the market narrative and drive performance going forward.
“More than anything, I believe investors need to consider being diversified heading into the end of the year,” he said. That is why he and his colleague, Chief Market Strategist Matt Orton, CFA, have talked so much about building balance in portfolios.
“And don’t try to naively play for any specific election outcome,” Del Guercio said. “It doesn’t work.”
After the next couple of weeks, he expects markets can look forward to positive seasonal trends and the unwinding of election hedges in the short term, followed by a robust growth outlook that he believes should support equities into 2025 and beyond. He said a correction, whether it be through price or time, should be viewed as a welcome opportunity to consider deploying capital into this strong economic backdrop. In that context, Del Guercio’s investment playbook focuses on what he sees as three key areas of opportunity:
Cyclicality. While defensive stocks have been in vogue over the past few quarters, the tailwinds that led to their outperformance have begun to sputter, bolstering the case for leaning into cyclicality going forward, he said. Recession fears have faltered with the outlook for a more robust economy reigniting concerns over the stickiness of inflation and prompting investors to question whether interest rates will be structurally higher for longer. Energy, insurance, and banks are the parts of the market most positively correlated to rising bond yields. Energy has been a laggard but has the added benefit of being a geopolitical hedge while financials have posted the largest third-quarter EPS beats (+9.4% in aggregate) as an S&P 500 sector, raising hopes for continued outperformance. Del Guercio said industrials look attractive with prospects for continued strong performance from aerospace and defense companies as global defense budgets rise, and electrical equipment companies riding the tailwinds from artificial intelligence and electrification.
Small caps. Small caps have yet to make a new all-time high since November 2021, but Del Guercio said they look primed to make up for lost time. Small caps continue to benefit from the soft-landing narrative’s materialization, while also getting a potential boost from the “Trump trade” — the idea that a Trump victory could bring policies that benefit certain industries — with expectations for deregulation and a capital markets boom auguring well for small caps. He said don’t forget that small caps are expected to come out of their multi-year earnings recession with expectations for the Russell 2000 to post its first quarter of EPS growth in the fourth quarter before accelerating ahead of large caps through 2025. When small caps eventually break out, Del Guercio said it could be rapid as underweight investors crowd in to a trade where they currently lack adequate exposure.
India. Del Guercio maintains that India continues to be the best long-term opportunity in emerging markets, and the Indian NIFTY 50 Index is currently in a rare but still shallow pullback. While India isn’t cheap, he said that’s for good reason: you have to pay up for growth. He said this country has “undeniable demographic tailwinds, especially compared to China,” and is a key beneficiary of supply chains getting repositioned away from China. Emerging markets are still broadly under-allocated to globally, and Del Guercio sees India as the most quality market within them.
Earnings: 169 S&P 500 companies are expected to report earnings this week, representing 44% of the index’s total market capitalization. The most attention will be paid to the five Magnificent Seven constituents that are scheduled to report. Additionally, important earnings insights on the state of the consumer and macroeconomic trends are likely to come from major companies in credit cards, healthcare, petroleum, semiconductors, fast-food, ride-hailing and food delivery, and more.
The labor market: the September Job Openings and Labor Turnover Survey (JOLTS) report comes out on Tuesday, the ADP® National Employment Report™ on Wednesday, and most importantly the non-farm payrolls report and unemployment rate is published Friday.
Growth and inflation: The first reading of third-quarter gross domestic product is released Wednesday, the Fed’s preferred inflation gauge — the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, or core PCE — comes out on Thursday, and the October Institute for Supply Management manufacturing Purchasing Managers’ Index arrives Friday.
Percent of S&P 500 sector by market cap reporting earnings per week
Source: Bloomberg, as of 10/28/2024.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of Oct. 25, 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
The ADP® National Employment Report™ is published monthly by the ADP Research Institute® in close collaboration with Moody’s Analytics. The ADP® National Employment Report™ provides a monthly snapshot of U.S. nonfarm private sector Employment based on actual transactional payroll data.
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%.
A beat is when a company’s reported earnings or other business results exceed or are better than the expectations of analysts and others who follow the company’s stock.
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.
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.
Core PCE, officially known as the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, is a measure of the prices that U.S. consumers pay for goods and services, not including two categories — food and energy — where prices tend to swing up and down more dramatically and more often than other prices. The core PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, measures inflation trends and is watched closely by the U.S. Federal Reserve as it conducts monetary policy.
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 stocks provide consistent dividends and stable earnings regardless of whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.
The dual mandate consists of two over-arching goals that influence the course of monetary policy set by the U.S. Federal Reserve. Those goals are maximum employment and stable prices. Maximum employment is defined as the highest level of employment or lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate.
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 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 Federal Reserve’s inflation target rate is the rate of price increases that the Fed prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by the Personal Consumption Expenditures (PCE) Price Index.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
A hedge is an investment or investment strategy that is designed to lessen the potential for losses in other investments. The price of an investment considered to be a hedge often moves in the opposite direction of the prices of the investments being hedged.
Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
The Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.
The Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics. The survey’s job openings rates consider month-to-month changes in the number of job openings reported on both a state and national level.
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.
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.
Seasonality refers to predictable changes that occur over a one-year period in a business, market, market sector, or economy based on the season, including calendar or commercial seasons.
A soft landing occurs when a central bank successfully adjusts interest rates to reduce inflation and slow economic growth while avoiding a recession.
The S&P Global Flash U.S. Composite PMI® is produced by S&P Global and is based on original survey data collected from a representative panel of around 800 companies based in the U.S. manufacturing and service sectors. The flash estimate is based on around 85% of total PMI survey responses each month and is designed to provide an accurate advance indication of the final PMI data.
Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.
Trailing indicators are data or measurements that reflect events, trends, results, or developments that took place in the past. Trailing indicators typically refer to a specific time period for which the data in question is aggregated, summed, or averaged. Trailing indicators help reflect trends that occur over specified periods of time.
Underweight describes a portfolio position in an industry sector or some other category that is less than the corresponding weight level in a benchmark portfolio.
Unwinding describes the process of closing out what is often a large or complicated trading position.
A zero interest rate policy (ZIRP) is when a central bank sets its target short-term interest rate at or close to 0%, typically to expand credit and stimulate economic activity.
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.
The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.
The NIFTY 50 Index is a stock index on the National Stock Exchange of India that tracks the largest assets in the Indian equity market. It is diversified across 13 sectors of the Indian economy: financial services, information technology, consumer goods, oil and gas, automobiles, telecommunications, construction, pharmaceuticals, metals, power, cement and cement products, fertilizers and pesticides, and media and entertainment.
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-633288 Exp. 2/28/2025
An uptick in volatility is still plausible with the election right around the corner, but the soft-landing narrative continues to materialize with investor optimism.
Earnings will come into focus over the next few weeks as investors attempt to gauge the durability of the ongoing expansion of market breadth.
The artificial Intelligence trade has not reached its end, but software and semiconductors are not the only ways to consider approaching this multigenerational megatrend.
“Sometimes it feels like the S&P 500 index seems to defy gravity,” said Joey Del Guercio, Market Strategy Research Associate at Raymond James Investment Management, “but I believe there is still plenty to be optimistic about.”
Last week was the sixth consecutive week of gains for the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average indices.1 And to underscore just how strong equity performance has been lately, consider the highlight reel for the S&P 500 Index alone:
It’s up 9 of the last 10 weeks, closed last Friday at its 47th all-time high of the year, and is up 22.95% year to date.
This is the S&P 500’s 13th best year-to-date performance through Oct. 18 since 1928 and its best year-to-date performance since 1997.
This also is the S&P 500’s third best year-to-date performance in the last 25 election years since 1928.
“The bears have been a bit quieter lately, and for good reason,” Del Guercio said. “I believe an uptick in volatility is still plausible with the U.S. presidential election right around the corner, but the soft-landing narrative continues to materialize with the peak of earnings season approaching as a potential positive catalyst.”
Del Guercio noted the case for a soft landing gained support last week with a few key data releases. The consumer continues to surprise to the upside month over month with September U.S. retail sales rising at 0.4% compared to the consensus expectations of a 0.3% increase and accelerating from August’s 0.1% rise.
September core retail sales, also known as the control group, as defined in the Personal Consumption Expenditures Price Index by the U.S. Bureau of Economic Analysis, excludes the most volatile categories of autos, gas stations, food/drinks, and building materials. The control group’s sales rose 0.7% month over month, far ahead of consensus expectations of 0.3% and August’s increase of 0.3%. This was the control group’s strongest reading since June of this year and its fifth straight increase.
Del Guercio also noted that last Thursday’s initial jobless claims came in softer at 241,000 versus the consensus expectation of 262,000 and the previous week’s 260,000. That was its sharpest decline in nearly three months. While 241,000 is still elevated mainly due to Hurricanes Helene and Milton, he said the markets welcomed the softer report.
“I view the volatility injected into the labor market as a net benefit for the soft-landing narrative,” said Del Guercio. “Thinking about labor data to come, I believe bad news would be more anticipated by both the market and the Federal Reserve and would allow both to have something to point toward as matching their expectations. If it’s a good report, then I believe that is a much better outcome given the added adversity.”
Del Guercio believes investors might continue to expect possible volatile reactions to key data prints going forward. The futures market is currently implying around a 95% chance of a 25-basis point (bp) cut at the Federal Reserve’s Nov. 7 meeting, as well as a total of around 1.76 cuts by the December meeting and around 2.5 cuts by the January 2025 meeting. He believes expectations for these cuts are likely based on the continuation of strong economic data that has given the Fed the ability to take a more measured approach to the path for rate cuts going forward.
Del Guercio said earnings will come into focus over the next few weeks as investors attempt to gauge the durability of the ongoing expansion of breadth. The S&P 500’s third-quarter earnings season unofficially kicked off with the banks two weeks ago, and he believes we’re off to a decent start. To date, 14% of S&P 500 companies have reported. Among these companies, 79% have beaten expectations on average by 6.1%. Financials have been notably strong, beating earnings per share (EPS) expectations by 10% in aggregate thus far. Results have supported the soft-landing narrative as capital markets activity has improved and bank commentary has noted the resilience of consumer spending.
Consensus estimates currently expect the S&P 500 EPS to grow by 3.4% year over year in the third quarter. Beneath the surface, expectations are for the Magnificent 7’s EPS to grow by 18.1% while the EPS of the S&P 493 (the rest of the S&P 500 minus the Magnificent 7) grows at 0.1%. At face value, that spread in EPS growth projections might seem concerning, but Del Guercio noted that the second quarter was the S&P 493’s first quarter of EPS growth since 2022.
Five sectors are currently expected to outpace the index’s earnings growth
FactSet S&P 500 third-quarter EPS growth estimates: current vs. pre-season
Source: FactSet, as of 10/18/2024.
Furthermore, Del Guercio believes expectations beyond this quarter look constructive for the overall index. Over the next five quarters, he said the Magnificent 7 and the S&P 493 are both expected to post double-digit EPS growth. He believes these expectations for a continued broadening in the index’s overall EPS growth should augur well for breadth to continue to expand.
“The fact that the S&P 500 is up 22.95% year to date is probably the best example of the value of staying invested in the face of relentless pessimism from a few outspoken cynics,” said Del Guercio. “Being bearish often sounds more sophisticated and everyone wants to be like Michael Burry before the Global Financial Crisis. In retrospect, it looks like the bulls were the true contrarians of 2024.”
He believes investors can expect an uptick in volatility with the election and the Fed’s November meeting fast approaching, along with persistently heightened geopolitical tail risk.
Del Guercio reiterated to remember that “time in the markets beats timing the markets.” He expects and welcomes any volatility and sees downside as a potential opportunity with the long-term economic outlook on what he considers to be solid footing. There is ample opportunity to be optimistic, he said, and consequently he’s thinking about three key themes:
“Bipartisan” investments. With the election coming up, Del Guercio recommends against thinking about investing for a specific outcome. Instead, he suggests considering long-term themes with what he sees as having bipartisan support like re-shoring, domestic infrastructure, and defense.
The long-term opportunity in “AI 2.0.” Last week was a reminder that the artificial intelligence (AI) trade has not reached its end, but Del Guercio acknowledged that the blistering trailing performance of the main AI beneficiaries makes it increasingly difficult to stomach buying in. Fortunately, he said, software and semiconductors aren’t the only ways to consider playing this multigenerational megatrend. Instead, he proposes considering the more tangential beneficiaries on the receiving end of the hyperscalers’ immense capital expenditures. Industrials broadly, and electrical equipment specifically, remain attractive to Del Guercio as AI’s infrastructure gets built. Separately, utilities remain potentially attractive as they’ll be tasked with distributing larger amounts of electricity going forward with select power generators possibly getting a huge boost from the continued nuclear demand to meet AI energy demands.
Small caps. Small caps have continued their march higher. The Russell 2000® Index is now only about 7% below its 2021 all-time high. Del Guercio hopes that small caps’ recent outperformance reminds investors of the potential opportunity down the market cap spectrum. He expects that this stratum of equities could benefit from lower interest rates, any continuation of the soft-landing narrative, and breadth continuing to expand down from the top-heavy indices like the S&P 500.
The next two weeks are about earnings, Del Guercio said. This week brings reports from 112 S&P 500 companies that account for 15% of the index’s market capitalization. Next week spotlights 181 companies, accounting for 45% of the index’s market cap, and includes potentially significant reports from aerospace and defense companies, some AI 2.0 beneficiaries, and some companies with potential insights on the economy and consumer.
The U.S. economic calendar features:
Mortgage Bankers Association purchase applications, existing home sales, and the Fed’s Beige Book on Wednesday.
The Institute for Supply Management’s manufacturing and services Purchasing Managers’ Indexes, plus weekly jobless claims and new home sales on Thursday.
Durable orders and the University of Michigan Index of Consumer Sentiment on Friday.
1 Unless otherwise indicated, all data cited is sourced from FactSet as of Oct. 18, 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.
Commodities and currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising, Precious metal investing is subject to substantial fluctuation and potential for loss.
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%.
A beat is when a company’s reported earnings or other business results exceed or are better than the expectations of analysts and others who follow the company’s stock.
The Beige Book, officially known as the U.S. Federal Reserve’s Summary of Commentary on Current Economic Conditions by Federal Reserve District, is published eight times per year. The summary gathers anecdotal information on current economic conditions through reports from bank and branch directors and interviews with key business contacts, economists, market experts, and other sources.
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.
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.
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 Federal Reserve’s inflation target rate is the rate of price increases that the Fed prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by the Personal Consumption Expenditures (PCE) Price Index.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
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.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
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.
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. The non-manufacturing Purchasing Managers’ Index (PMI), also known as the ISM Services PMI, measures the prevailing direction of economic trends in the non-manufacturing sector. It is created by the Institute for Supply Management (ISM).
Magnificent 7 refers to the seven largest stocks by market capitalization in the S&P 500 index. Collectively they make up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon, 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.
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 Mortgage Bankers Association Weekly Applications covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.
The retail control group represents the total industry sales that are used to prepare the estimates of the Personal Consumption Expenditures Price Index for most goods. Those sales include total retail trade, less automobile dealers, building material and garden equipment and supplies dealers, gasoline stations, office supply and stationery stores, mobile home dealers, tobacco stores, and gasoline sales at warehouse clubs, supercenters, and grocery stores, except for convenience stores.
A “soft landing” occurs when a central bank successfully adjusts interest rates to reduce inflation and slow economic growth while avoiding a recession. A “hard landing” occurs when a central bank’s unsuccessful management of interest rates causes a recession. The term “no landing” is sometimes used to describe situations where inflation remains elevated and economic growth continues while central banks leave interest rates unchanged.
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 opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.
Trailing indicators are data or measurements that reflect events, trends, results, or developments that took place in the past. Trailing indicators typically refer to a specific time period for which the data in question is aggregated, summed, or averaged. Trailing indicators help reflect trends that occur over specified periods of time.
The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.
Indices
The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq.
The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.
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.
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-630131 Exp. 2/21/2025
Volatility remains elevated, reflecting uncertainty over the path of interest rates, the possibility of a contested U.S. election and heightened geopolitical tensions.
Consensus estimates for the S&P 500 look for a reacceleration to double-digit earnings growth in the fourth quarter and 2025, which raises the importance of forthcoming earnings results and management commentary.
Themes to consider include cyclicality, the long-term potential of small caps, and beneficiaries of the artificial intelligence buildout.
“Earnings season is kicking off at an interesting point and is raising the importance of the market seeing continued strength from corporate America,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management.
Orton said other positive economic reports have forced investors to pare back their expectations for an aggressive rate-cutting cycle. Just a few weeks ago there was 180 basis points (bps) of monetary loosening, including at least one further 50-bp cut this year, priced into money markets by the end of 2025, but Orton said equities have held up remarkably well as this has adjusted and rates have moved higher.
While the super-sized start to the interest rate-cutting cycle had many investors more optimistic about the prospects of a soft landing, sticky inflation data coupled with rising geopolitical tensions and a contentious U.S. election are leading to increased uncertainty around the path of rate cuts going forward. These factors increase the likelihood that we’ll see continued dispersion through earnings season, where misses are likely to be penalized sharply and beats coupled with strong guidance could be required to keep moving higher.
This increased focus on fundamentals is a good thing, Orton said, as some of the lower-quality investments that rode the interest rate-cut or artificial intelligence (AI) waves should be brought back to earth. It’s worth noting that the results reported from the large banks on Friday were encouraging, with better than expected management outlooks, particularly around net interest margins and the recovery in investment banking.1 While some of the recent inflation data has some investors on edge about a pause in the rate-cutting cycle in November, Orton sees that as too abrupt a shift after having cut 50 basis points (bps), particularly as most U.S. Federal Reserve (Fed) officials still appear to be convinced that rates are in restrictive territory.
“I continue to see 25-bp cuts at each of the year’s remaining meetings,” Orton believes. “Overall, the backdrop remains quite supportive for risk assets going forward. The rising tide might not be lifting all boats anymore, but I believe that creates a healthy environment for higher-quality companies with strong fundamentals to outperform. I continue to encourage investors to consider using downside opportunistically and to think about building more balance in portfolios by leaning into cyclicality but maintaining exposure to growth.”
Results from this earnings season will be important, especially the commentary and guidance from management teams, given that consensus estimates look for a reacceleration to double-digit earnings growth in the fourth quarter and 2025. Historically, the third-quarter earnings season has been a period of strong equity returns, with the largest absolute moves often occurring during this time. Orton thinks this is largely due to the critical nature guidance for the next calendar year and that investors look to corporations to provide reassurance on the future growth narrative. In addition to focusing on the prospects for 2025, Orton expects it will be important to see a continuation in some of the recent trends supporting this bull market. In particular, he said it has been encouraging that the broadening of earnings we’ve seen over the past few quarters has been translating into an increased breadth in prices, and companies need to deliver to sustain this trend.
“I think the bar is set pretty low with the consensus estimates looking for only 4.4% earnings per share growth in the third quarter,” Orton said. “I expect to see closer to 7%-plus growth based on the average beat percentages observed over the past few years.”
Orton also thinks the market underestimates the results in more cyclical parts of the market like financials, industrials, and materials. He believes these are all parts of the market that have some good opportunities given their relatively attractive valuations and the possibility that there is now a floor to Chinese economic growth.
Orton said it’s worth diving into a bit more detail on how the narrowness that dominated 2023 and the first half of this year has evolved over the past quarter. As of 4/30/2024, the S&P 500’s top five contributors (NVDA/AMZN/META/LLY/GOOG&GOOGL) contributed 69% of the index’s year-to-date gain (4.21% of the S&P 500’s 6.04%). Critically, the increase in breadth is evident in the fact that about 80% of S&P 500 constituents are posting positive returns year to date while 34% are outperforming the index’s gain of more than 23% as of Oct. 11. The S&P 500® Equal Weight Index also is finally pushing new high after new high and so far is outperforming the cap-weighted index by 3.13% in the second half of this year. All of this gives Orton increased confidence in the sustainability of the bull market.
On the economic front, Orton said we’re at an interesting juncture where data is once again surprising to the upside. Activity data has been better than expected. Consumption has held up along with the jobs market, and gross domestic product (GDP) growth estimates are actually being revised higher. At the same time, Orton believes monetary policy is shifting from a headwind to a tailwind, which he expects to provide a boost to the most rate-sensitive expenditure components of GDP. This includes consumer durables consumption, business equipment investment, and residential investment.
“We got a reminder last week that the fight against inflation hasn’t been won yet,” Orton said, “but I don’t think the data will slow the gradual rate-cutting path of the Federal Reserve and I still expect inflation to normalize back to target next year.”
Orton expects this benign economic backdrop to provide additional support for cyclicals going forward. Despite the continued equity bull market, cyclicals excluding information technology have underperformed defensives over the last six months, he said, though that’s started to change recently. Orton expects this to continue as earnings provide a reminder of the solid fundamentals and outlook within cyclicals while the reversal in bond yields also deflates some of the run-up in the defensive trade.
The S&P 500 continues to march higher, hitting another all-time high on Friday, and Orton continues to be optimistic on the path forward. Despite the march higher in equities, volatility remains elevated across equities, fixed income, foreign exchange, and commodities. This signals some reticence over the uncertainty related to a potentially contested U.S. election and heightened geopolitical tensions. Rates have also pushed higher given positive economic data and stickiness on the inflation front, pushing the 10-year U.S. Treasury yield north of 4.1% — up nearly 50 bps since the lows following the Federal Open Market Committee (FOMC) meeting in September.
Orton said the solid economic backdrop is starting to be confirmed by bank earnings. Corporate margins are also near record highs, and the expectation for another strong earnings season are corroborating the push higher in the market, while he said “There’s also no need to chase the market higher,” Orton said. “Investors can weigh whether to use downside opportunistically and think about leaning into cyclicality and maybe consider whether to balance that with exposure to smaller companies and global markets. I also maintain it’s not time to abandon growth stocks, which I believe are poised to perform well as fundamentals remain solid and a gradual rate-cutting cycle are still playing into their favor.”
With those thoughts in mind, Orton’s investment playbook includes three key themes:
Cyclicality. Orton expects the jump in interest rates and concerns over the stickiness of inflation to keep a floor on how low rates can go for a while. Accordingly, he suspects that defensive stocks will give back some of their outperformance as a result, especially as he thinks investors rightly question whether rates will be structurally higher going forward. The parts of the market most positively correlated to rising U.S. bond yields are energy, insurance and banks. Financials have performed well, but Orton suspects earnings over the next two weeks could give the sector another jolt. Other cyclical areas like industrials also look attractive, he said, noting that the sector is finally breaking out of a prolonged period of relative underperformance. Orton’s preferred areas within cyclicals include industries like aerospace and defense and electrical equipment. “Given the importance of selectivity in this market, I believe investors can consider looking to these areas of the market in the search for potential exposure to the trends that will drive growth going forward.”
The “AI 2.0” basket. Semiconductors and software aren’t the only ways to play artificial intelligence, Orton said. While the market might question the valuations and long-term winners/losers across technology broadly, he believes the plays focused on the buildout of AI infrastructure remain on solid footing. Orton believes these tech-adjacent, “AI 2.0,” opportunities will be prime beneficiaries of the capital expenditures arms race among hyperscale tech giants expected to spend more than $400 billion over the next two years alone. Data centers are already a global market of more than $200 billion, and AI adoption is expected to accelerate data center growth with AI chips (e.g., graphics processing units) that required three to four times more electrical power versus traditional central processing units (i.e., CPUs) while generating vastly more heat. This increases the need for data center services within industrials (e.g., companies that provide liquid cooling) as well as the electric utilities that must modernize the antiquated grid in the face of surging electricity demand.
Earnings are the main event on the economic data calendar, with reports coming from financials and healthcare, plus key players in semiconductors, video streaming, and consumer products.
The Fed officials scheduled to make public comments this week include Federal Reserve Bank of Minneapolis President Neel Kashkari, Board of Governors member Christopher Waller, and Federal Reserve Bank of San Francisco President Mary Daly.
China also is scheduled to release data on consumer prices, producer prices, GDP, its trade balance, and aggregate financing figures, which will help with the assessment of China’s economic stimulus efforts and the scale of a potential fiscal package.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of October 11, 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
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%.
A beat is when a company’s reported earnings or other business results exceed or are better than the expectations of analysts and others who follow the company’s stock.
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.
The Citi Economic Surprise Index is a weighted sum of economic surprises in the past 90 days. Surprises are weighted by their impact on the market and weights that are adjusted over time. Recent surprises are weighted more heavily than older ones.
A central processing unit (CPU) is the primary part of a computer that processes data and handles the computer’s execution of commands and overall functions.
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.
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 stocks provide consistent dividends and stable earnings regardless of whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.
Dispersion refers to the range of outcomes in different areas of a financial market or to the potential outcomes of investments based on historical volatility or returns.
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 Federal Reserve’s inflation target rate is the rate of price increases that the Fed prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by the Personal Consumption Expenditures (PCE) Price Index.
A graphics processing unit (GPU) is a type of electronic circuit used in a wide range of applications that include parallel processing, graphics and video display, and artificial intelligence.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
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.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
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.
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.
Liquid cooling is a process that uses a liquid coolant, which is more efficient than air alone, to help absorb and dissipate heat from an energy-intensive facility such as a data center.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Momentum investing is a strategy that aims to capitalize on the continuance of an existing market trend. It is a trading strategy in which investors buy securities that are already rising and look to sell them when they look to have peaked. It entails taking long positions on financial instruments with prices trending up and short positions on instruments with prices trending down.
A net interest margin compares the net interest income a bank generates from credit products like loans and mortgages with the outgoing interest it pays holders of savings accounts and certificates of deposit. Expressed as a percentage, net interest margin is an indicator of profitability indicator that reflects the chances of a bank thriving over the long term.
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 opposite of a tailwind is a headwind, which contributes to an investment’s underperformance.
An under-owned stock is a stock that is not widely owned, and is often considered an opportunity. The term is often used to describe stocks that are less popular and may be undervalued.
Underweight describes a portfolio position in an industry sector or some other category that is less than the corresponding weight level in a benchmark portfolio.
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.
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 96% 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-623027 Exp. 2/14/2025
A strong payrolls report and other economic data have undermined investor expectations for aggressive interest rate cuts from the U.S. Federal Reserve (Fed).
Matt Orton, CFA, Chief Market Strategist, sees the sanguine economic backdrop supporting the further broadening of earnings growth.
Worth considering: Secular growth trends that are agnostic to politics and already playing out in earnings.
The market has positive momentum heading into the start of earnings season this week, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. And that, he said, helps set the stage for some strong secular growth trends that he sees having the potential to drive opportunity through the end of the year.
“Strong economic data last week — particularly the blowout jobs report on Friday — all but confirms my expectation for a gradual Fed rate-cutting cycle,” he said. Not only did September employment significantly beat expectations, but job gains were also broad- based, and the report was accompanied by a 72,000-job upward revision to the gains reported in the preceding two months.1
Orton said other positive economic reports have forced investors to pare back their expectations for an aggressive rate-cutting cycle. Just a few weeks ago there was 180 basis points (bps) of monetary loosening, including at least one further 50-bp cut this year, priced into money markets by the end of 2025, but Orton said equities have held up remarkably well as this has adjusted and rates have moved higher.
“I believe that’s because this more sanguine economic backdrop further supports the broadening of earnings growth and its durability into next year,” he said. “Overall, I see this as a time for investors to consider leaning into a risk-on asset allocation and to think about increasing their balance to cyclical equities and small caps as fears of recession are, in my estimation, clearly overblown. Geopolitical risks remain high, and rather than chasing the market, I continue to advocate for considering being ready to use downside opportunistically.”
Earnings season kicks off in earnest at the end of the week, and Orton said he hopes it will provide some grounding to strong market fundamentals should any developments in the Middle East cause a knee-jerk reaction.
Recent stronger than expected economic data was not limited to the September jobs report, Orton noted. Institute for Supply Management surveys and the Job Openings and Labor Turnover Survey (JOLTS) published last week pointed to the U.S. economy holding up surprisingly well. The headline Services ISM® Report on Business® beat expectations in September, driven by a notable rise in new orders, pointing to continued resilience in the service sector of the economy. Additionally, Orton said a substantial upward revision in economic output in the U.S. Bureau of Economic Analysis’s national accounts data provides a strong sign that there might be less downside risk for the economy than many investors have expected. At this point, he said it’s hard to imagine upcoming data leading the U.S. Federal Reserve (Fed) to cut interest rates by 50 basis points in November or December.
September’s surprisingly sanguine payroll report curbs recession fears
Summary of 76 economists’ estimates
Source: Bloomberg, as of 10/4/2024.
Despite the more supportive economic backdrop, Orton expects dispersion in market performance will remain “quite elevated” during earnings season as investors seem to favor companies with good execution and penalize those with guidance that misses consensus estimates. Earnings results last quarter were quite strong and the broadening in earnings growth continued across more cyclical sectors like financials and materials while also seeing strength in information technology. Heading into third-quarter earnings, the estimated year-over-year earnings growth rate for the S&P 500 Index is 4.2%, which would mark the fifth consecutive quarter of earnings per share (EPS) growth for the index. Profit margins are expected to remain resilient at 12.1%.
The financials sector will be in focus over the next two weeks as it dominates early earnings releases. Banks are once again the only industry group expected to report a year-over-year decline in earnings. Orton plans to pay attention to the nuances between regionals and diversified banks as well as to guidance, which will ultimately be critical for maintaining the strong gains over the past few months.
The fundamental backdrop for the market is strong, Orton said, while the technical backdrop remains supportive of further long-term upside even though it is a bit stretched after the S&P 500 delivered its fourth consecutive weekly gain and its third consecutive all-time weekly closing high. But lurking beneath the surface is heightened geopolitical risk and a fraught U.S. election in less than a month. While the trend in equities remains higher, Orton said it’s worth pointing out that the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, has remained elevated along with heightened volatility across foreign exchange, interest rates, and commodities. With the S&P 500 within a whisper of another all-time high, he said there’s no reason to chase the market higher.
“I expect to continue to have opportunities to consider redeploying capital into drawdowns,” he said. “I believe the key is thinking ahead and working to have a plan ready to execute, depending on each investor’s situation. In particular, now is an apt time for investors to give some thought to leaning into the broadening market through secular growth trends that are agnostic to politics and already playing out in earnings.”
Accordingly, Orton’s playbook focuses on several of those trends:
Consider playing offense with defense. Orton has highlighted what he sees as the attractiveness of the defense space over the past quarter, but he says it really came into focus last week with a ratcheting up in Middle East tensions, resulting in big gains for defense-related companies. The defense industry has been inflecting higher for some time due to a more belligerent global threat environment. Defense spending relative to U.S. gross domestic product (GDP) remains suppressed, but it’s inflecting higher, and while the United States has been and will continue to be NATO’s biggest defense spender, Orton said there’s an ongoing expectation that other NATO members will increase their defense spending to at least 2% of GDP per year on an ongoing basis. He continues to expect better top- and bottom-line results going forward and he said the opportunity set still looks attractive.
Small caps. The small-cap indices continue to build a base of higher highs and higher lows and have the potential to break out higher, Orton said. The economic environment continues to improve as growth fears abate. While rate cuts might not be as rapid as the market initially expected, he said the gradual path of cuts could support risk assets. Ultimately, he said, small-cap earnings have to deliver. If small caps’ EPS growth finally starts to match or exceed that of large caps and revisions inflect higher, Orton suspects more institutional investors will come off the sidelines. He said it’s also worth noting that a large percentage of Russell 2000® Index’s companies have free cash flow that exceeds EPS, a sign of fundamental strength that tends to signal strong future returns.
Is the rally in China sustainable? China has gone from worst to first, with China’s Hang Seng Index surging nearly 22% to close the third quarter in response to a series of stimulus measures. This now makes China the best-performing equity market this year, but many investors question whether this move will be sustainable and what the ultimate economic impact will be. First, Orton said, we need to separate the market from the economy. He is still skeptical that the policy announcements will ultimately change the demand-driven issues facing the Chinese economy, but the recent stimulus is very market-friendly. That stimulus includes more stock market support, which he noted may eventually include a stock market stabilization fund. Second, more and cheaper credit is available for lending. And third, there is more support for China’s real estate sector. Orton thinks this will enable China’s momentum to continue into the fourth quarter. That said, he believes investors should think about becoming increasingly discerning in what they buy “as the rising tide will not lift all boats for too much longer.” One key implication more broadly is that emerging market equities are breaking out from a multi-year base, largely supported by Asian markets. Some foreign investors also are reducing their overweight positions in Japanese stocks and reallocating back to China: There were net sales by foreign investors of more than $20 billion from Japanese cash equities in the first three weeks of September. On the other hand, he noted that there hasn’t been a meaningful foreign selling in India or in the MSCI Emerging Markets ex-China Index as there remain structural demand for non-China exposure regardless of recent policy changes. Orton said he thinks it makes sense to consider buying the dip in countries like India where markets have pulled back slightly over the last week. Also, for investors who don’t want direct China exposure, he said there are potential opportunities for tangential exposure in global miners, particularly those focused on commodities like copper that also have strong secular demand trends, as well as in European industrials.
Cyclicality. While value has certainly outperformed growth from a pure index style perspective, Orton pointed out that historically speaking, growth, small caps, and higher-beta stocks tend to outperform in a slow rate-cutting environment. While sectors like utilities have been the big outperformer this quarter, he believes they are no longer just a defensive play. Rather, he sees utilities with exposure to data center growth as driving the sector’s outperformance. Rather than bank on value outperforming simply because rates are coming down and many sectors still look favorably valued, Orton said he prefers to think about leaning into cyclicals where the lift to earnings could continue to come from powerful economic growth trends such as artificial intelligence, reshoring, and defense. He also noted that industrials finally have started to break out of a prolonged period of relative underperformance. He likes sectors like electrical equipment due to data center exposure and machinery due to a lift from infrastructure and maybe a stronger Chinese economy.
“Given the importance of selectivity in this market, I believe investors can give serious thought to looking to these areas of the market to find value and get exposure to the trends that I believe will drive economic growth going forward,” he said.
Minutes from the September Federal Open Market Committee (FOMC) meeting come out Wednesday. Thursday brings U.S. inflation data, though Orton doesn’t expect much in the Consumer Price Index to challenge the Fed’s confidence that inflation is moving sustainably back to its 2% target. Also on the economic calendar is the Producer Price Index report and the preliminary University of Michigan Index of Consumer Sentiment survey for October.
Twelve of the FOMC’s 19 members are scheduled to speak this week. Two appearances with the potential to be substantial are Federal Reserve Bank of Atlanta President Raphael Bostic speaking on the economic outlook Tuesday and Federal Reserve Bank of New York President John Williams speaking Thursday.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of October 4, 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.
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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.
Commodities and currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising, Precious metal investing is subject to substantial fluctuation and potential for loss.
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%.
Beta is a measure of the volatility or systemic risk of a security, group of securities, or portfolio compared with the market as a whole.
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.
“Buy the dip” refers to an investment strategy that consists of buying an asset or group of assets when the price has dropped on the theory that the decline will not last and that the price is likely to rise again and thus represents a discount.
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.
Defensive stocks provide consistent dividends and stable earnings regardless of whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.
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 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 Federal Reserve’s inflation target rate is the rate of price increases that the Fed prefers to see to ensure the economy will remain stable. Generally, the Fed’s target rate is 2%, as measured by the Personal Consumption Expenditures (PCE) Price Index.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
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.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
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 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.
The Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics. The survey’s job openings rates consider month-to-month changes in the number of job openings reported on both a state and national level.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
National economic accounts data, published by the U.S. Bureau of Economic Analysis, include statistics that have been aggregated to provide a comprehensive view of U.S. production, consumption, investment, exports and imports, and income and saving. These statistics are best known by summary measures such as gross domestic product (GDP), corporate profits, personal income and spending, and personal saving.
NATO, or the North Atlantic Treaty Organization, is a political and military alliance of 32 countries from Europe and North America that is organized to guarantee their security and cooperation.
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 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.
A profit margin measures how much income or profit a company generates as a percentage of revenue. It can be expressed as a percentage or a decimal.
Reshoring describes an effort to bring manufacturing and other services back to the United States from overseas operations.
A risk-on investment is typically fueled by a strong growth environment and is more apt to rise when good news fuels bullish sentiment and investor expectations of favorable risk/reward ratios.
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.
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.
The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
The VIX – officially known as the Chicago Board Options Exchange (CBOE) Volatility Index is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.
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 Hang Seng Index includes the largest and most liquid stocks listed on the Main Board of the Stock Exchange of Hong Kong.
The MSCI Emerging Markets ex China Index captures large and mid cap representation across 23 of the 24 Emerging Markets (EM) countries excluding China. With 673 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. EM countries include Brazil, Chile, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.
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-615296 Exp. 2/7/2025
