“
”Markets in Focus
Timely analysis of market moves and sectors of opportunity
Volatility is likely to pick up in advance of the upcoming election, but we could see more highs heading into year-end as the market continues to grind higher.
It took two years of pain and hard work to recover from the stock market drawdown of 2022. Now Matt Orton, Chief Market Strategist, CFA, sees this as a time when investors should consider embracing the all-time highs this year.
Many investors are hiding out in money market funds and fear a major correction after a strong run, but Orton sees plenty of opportunities for investors to explore across the market.
September started with some typical weakness due to economic concerns and questions around the U.S. Federal Reserve (Fed), but it ended at an all-time high.
“The bull market is alive and well,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, “and while volatility might pick up with elections coming into focus and some important economic data releases, I continue to believe that we’ll see more highs heading into the end of the year as the market continues to grind higher.”
Orton has been most encouraged by the improvement in market breadth, both across sectors and market capitalizations. The third quarter’s top-performing sectors were utilities, real estate, industrials, financials, and materials. Both the Russell 2000® Index and the S&P 500® Equal Weight Index surged ahead of the cap-weighted index in the quarter, outperforming the S&P 500 by 3.53% and 4.00%, respectively, as of Sept. 27, 2024.1
“From a technical perspective, the set-up also looks encouraging,” Orton said. He noted that 79% of the S&P 500 Index members are trading above their 200-day moving average. This is above their five-year average of 62%. However, it has yet to reach 85%, 2024’s peak back in March. “This highlights that the market hasn’t become too stretched,” he said.
Earnings season kicks off at the end of next week, and Orton believes it will be critical to sustain these healthy trends. He’s optimistic and looks forward to what the money center banks say about the state of the American consumer.
“I believe mega-cap stocks and technology leadership need to hold up,” Orton said. “Recent earnings from a top memory solutions company provide encouraging signals for the artificial intelligence semiconductor space, and technology’s recent stagnation could provide an interesting opportunity. Overall, I think that investors might want to consider the possibility of leaning into a risk-on asset allocation and might consider increasing balance to cyclical equities and small caps as recession fears seem overblown.”
Orton believes there are many parts of this market that are just starting to break out. He said investors might consider leaning into near-term volatility around noisy data and risks associated with elections or other significant events, possibly re-evaluating their portfolios for these trends into next year.
Orton expects a busy week from a data perspective with the focus on the U.S. jobs market. He believes decent employment data might push back against the current market pricing of a more aggressive rate cut trajectory than he believes is warranted. If that’s how the data comes in, then Orton wouldn’t be surprised to see U.S. Treasury yields rise slightly as a result.
“I do not think this will be an issue for the bull market, and I believe any volatility as a result could be used to consider the idea of putting more capital to work,” Orton said. “There are several reasons not to expect a recession. This includes a lack of weakness in the most cyclical parts of demand and the failure of other labor market trends to corroborate the rise in unemployment.”
Orton hasn’t seen significant imbalances in the economy develop like they typically do before a recession. Plus, he believes financial conditions are easing. Inflation is coming down while the economy is slowing, but not breaking. Orton finds this could be a supportive backdrop for risk assets.
“I want to drive home the point that investors should consider embracing this environment, not continuing to worry about it,” Orton said. “There was a great article in the Wall Street Journal last weekend called The Fed made its move. Why didn’t I?. It highlighted there are still too many investors hiding out in money market funds. Perhaps, they don’t know it’s the easy way out.” Orton believes some investors worry that the market is due for a major correction after an incredibly strong run.
“I will continue to pound the table for thinking about embracing the all-time highs this year, as they came after two years of pain and hard work to recover,” Orton said. “U.S. growth has remained strong, and gross domestic product data last week showed unambiguously strong revisions.”
Orton said final domestic demand has grown at a seasonally adjusted annual rate (SAAR) north of 2.5% in each of the last six quarters. There’s scope for the productivity increases to actually put the economy earlier in the cycle than many have thought. Orton believes this positive fundamental backdrop helped to buoy earnings and put the S&P 500 on track to close the third quarter with a year-to-date gain of 20.8%. This is the seventh strongest performance for the first nine months of the year since 1957.
“Historically speaking, this tends to bode well for market performance in the fourth quarter,” Orton said. “In the 14 prior years when the S&P 500 Index gained 15% or more during the first three quarters, the fourth-quarter median gain was 5.44%. This includes a strong hit rate that was positive 11 out of 14 times: That’s 78.6% of the time.”
A quarter of catch-up
Quarterly index returns relative to the S&P 500
Source: Bloomberg, as of 9/27/2024.
Orton said the worst fourth-quarter period was the crash of 1987, down 23.2%. The other two negative fourth quarters were 1967 and 1983, with minor losses of 0.25% and 0.69%, respectively. Orton finds these statistics encouraging and suggests investors consider participating in the market and think about being ready to use downside in an effort to consider the idea of repositioning their portfolios dependent upon their individual situations.
Orton points out that the rotation beneath the surface dominated the third quarter, with an increase in earnings breadth finally starting to translate to increased breadth in prices.
“I think this rotation might continue if earnings remain solid, which could make the fourth quarter another quarter for breadth to continue catching up,” he said. “This increase in breadth has helped buck the seasonal trend of a weaker third quarter.”
Orton said the third quarter is historically the only period in which the S&P 500 Index has recorded an average negative return since 1980. Fourth-quarter returns are historically the strongest and most frequently positive compared to the other quarters. He added only 59% of third quarters have had positive returns, which is the index’s worst quarterly batting average. However, more than 80% of the S&P 500’s fourth quarters have been positive. Orton believes plenty of opportunities remain across the market. He highlights four on this chart, but says this is not an exhaustive list.
With that in mind, Orton’s investment playbook is focused on a few key areas:
Small caps. Orton sees some sustainable signs of life down the market cap spectrum with the Russell 2000® Index outperforming the S&P 500 by 243 basis points (bps) since the Fed rate cut on Sept. 18. Small caps have been outperforming quarter to date for the third quarter, but Orton said an easing cycle with falling rates and borrowing costs could drive even better relative performance going forward. Despite the recent outperformance, Orton believes several extremes remain between the relative performance of large versus small caps. For example, the two largest companies in the S&P 500 Index are bigger from a market capitalization perspective than the entire Russell 2000 Index, and the top five companies are 4.3 times larger than the entire Russell 2000 Index.
“Small-cap valuations on an absolute and relative basis could remain attractive, and small-cap earnings growth seems to be at an inflection point,” Orton said. “If smaller companies start to deliver growth and revisions start to tick higher, then I think that could be more than enough to possibly keep the macroeconomic backdrop supportive of small cap outperformance.”
Global diversification. Orton said the massive rally in Chinese equities spurred by the announcement of a rate cut and other various policy easing measures dominated trading last week.
Equities around the world with significant Chinese revenue exposure sharply reversed their downtrends. This is especially visible in the charts of European luxury goods companies and global miners. Orton believes the People’s Bank of China policy package could be enough to put a floor around current equity valuations where the deflationary reality is more or less discounted. Orton said it will be critical to see the market follow through this week as well as for China to provide additional fiscal measures going forward to sustain the rally.
“I’ve been very negative on China, and rightfully so, but if we see a fiscal bazooka that could certainly change,” Orton said. “However, the capitulation in China should put our focus on other opportunities globally and highlight the opportunities that exist around the world. India, my most preferred region globally, has continued to see all-time highs in the NIFTY 50 Index.”
Orton said outside of emerging markets, the STOXX® Europe 600 Index surged to new all-time highs last week . He believes an increasingly positive case can be made to see a more rapid earnings recovery globally and that would support the case for investors to explore the potential to add portfolio exposure outside of the United States.
Cyclicality. Orton said value has outperformed growth from a pure index style perspective, but 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 in the third quarter, Orton believes they are no longer just a defensive play. He said instead utilities with exposure to data center growth are driving the outperformance.
“Rather than bank on value outperforming simply because rates are coming down and many sectors still look cheap, I prefer to lean into cyclicals where the earnings lift can continue to come from these powerful growth trends in the economy,” he said. “Some examples include artificial intelligence, reshoring, and defense.
“Industrials are finally breaking from a prolonged period of relative underperformance,” he said. “I like sectors such as 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, Orton believes investors can consider looking to these areas of the market to find value and get exposure to the trends poised to drive growth going forward.
Orton said it will be a busy week of data, culminating in the U.S. jobs report for September on Friday. Also, he believes global central bankers are back in full swing with appearances throughout the week alongside several important data releases.
European Central Bank President Christine Lagarde will discuss the latest rate reduction with the European Parliament. In the U.S., Federal Reserve governors scheduled to speak include:
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 27, 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.
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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 batting average, in finance, is a measure of the record of a manager or part of the market to beat the market consistently. It is calculated by dividing the number of quarters (or months) in which the manager or part of the market beat or matched an index by the total number of quarters (or months) in the period. For example, a manager who meets or outperforms the market every quarter in a given period would have a batting average of 100. A manager who beats the market half of the time would have a batting average of 50.
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.
A crash is a sudden and significant drop in the value of a market. Crashes can be triggered by deteriorating or suddenly changing economic conditions as well as by investor panic over falling asset prices.
Cyclical forces describe trends and changes in market conditions that occur as the economy passes through the business cycle’s stages of expansion, peak, recession, and recovery.
Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.
A daily moving average (DMA) is a calculation that takes the arithmetic mean of a given set of prices over the specific number of days in the past; for example, over the previous 15, 30, 100, or 200 days.
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.
An earnings inflection marks a sudden change in the direction and rate of change of earnings growth. Earnings inflections can lead to either positive or negative change.
An earnings recession is considered to be two or more consecutive quarters of declining corporate year-over-year profits.
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.
Final sales to domestic purchasers is a subset of the U.S. Bureau of Economic Analysis’ quarterly gross domestic product report. It is a measure of how much U.S.-based purchasers, not including the government, spend on both domestically produced and imported goods. It does not account for changes in inventories or net exports of goods sold outside the United States.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
A hit rate reflects the percentage of holdings in an index or investment portfolio that generate positive returns over a specified period of time.
Mega-cap tech stocks are the technology companies with market capitalizations that are in the trillions or hundreds of billions of U.S. dollars, levels that far exceed many of the other stocks in the S&P 500 Index.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Money center banks are large banks situated in economic hubs that primarily deal with governments, other banks, and big corporations.
Investor positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
Risk assets refer to investments such as equities, commodities, high-yield bonds, real estate, and currencies, where the value may rise or fall due to fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
A seasonally adjusted annual rate (SAAR) is a rate adjustment used for economic or business data, such as sales numbers or employment figures, that attempts to remove seasonal variations in the data. Most data is affected by the time of the year, and adjusting for the seasonality means that more accurate relative comparisons can be drawn between different time periods.
The summary of economic projections is produced following meetings of the Federal Open Market Committee and includes meeting participants’ projections of the most likely outcomes for real gross domestic product growth, the unemployment rate, and inflation for a forward-looking three-year window and over the longer run.
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.
Visibility reflects the degree to which a company’s management or the analysts who follow it can reliably estimate future near- or long-term performance.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The 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 MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the United States and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to US citizens but not applicable to citizens in the overseas country.
The MSCI Emerging Markets® Index measures the performance of large and mid-cap stocks across 24 emerging markets (EM) countries.
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.
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.
The STOXX® Europe 600 Index represents 600 large-, mid- and small-capitalization companies across 17 European countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.
M-615296 Exp. 1/30/2025
The cutting cycle has commenced, but the subsequent cuts could come at a more measured pace than markets are currently pricing in.
A sanguine economic outlook, coupled with a gradual reduction in rates, can support risk assets, but that doesn’t mean there won’t be bumps along the way.
Market leadership is shifting, creating potential opportunities for investors to consider in industries poised to benefit from the growth of artificial intelligence (AI), as well as in select commodities, small caps and emerging markets.
“Everyone seems to have an opinion about the Fed and its supersized start to the rate-cutting cycle,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “However, what anyone thinks the Fed should have done or should do going forward needs to be separated from what the Fed has broadcast that it could do.”
For the past 18 months, Orton said the market has been consistently incorrect about rate-cutting expectations, and we saw a decent amount of recalibration around the September Federal Open Market Committee (FOMC) meeting. He said the market still looks to be offsides to a more rapid and deeper cutting cycle than forecast.1
“The more sanguine economic outlook, coupled with a gradual reduction in rates, should support risk assets, but that doesn’t mean there won’t be bumps along the way,” Orton said. Markets can take some solace from the fact that if economic data does start to roll over, Orton believes the FOMC has the wherewithal to ease monetary policy more aggressively than projected.
However, Orton said there are many scenarios where the FOMC cuts less than expected. As a result, volatility could remain elevated in the very short term as the market remains focused on incoming data and noise around the U.S. presidential election.
“Absent any big surprises, the path of least resistance is higher and I remain encouraged by the gradual broadening of the market that continues to play out, plus the opportunities that I believe still exist for investors to consider increasing diversification in their portfolios,” Orton said.
He believes one of the most important takeaways from the September FOMC meeting is that the Fed cut by 50 basis points (bps) not because it had to, but because it could. With inflation forecasts coming down, unemployment forecasts ticking up, and a slight downgrade to gross domestic product (GDP) reflected in the FOMC’s summary of economic projections (SEP), Orton said this front-loaded cut is a risk management tool and shows the Fed is taking the risks to the labor market very seriously. Unless Fed officials become more concerned about the downside risks to the labor market, he expects to see a more measured pace of rate cuts going forward.
Critically, Orton said, rate cuts should not be viewed as a harbinger of recession or heightened economic concern. The real interest rate remains high, and the Fed is taking advantage of the room it has to bring borrowing costs down.
Furthermore, the Fed has ample space to act more aggressively if labor market conditions continue to soften. Orton thinks that can support risk assets going forward, and it further supports additional market broadening heading into year-end.
“Despite equity markets sitting at or near all-time highs, there are still opportunities for investors to think about repositioning their portfolios, especially if volatility remains elevated heading into the presidential election,” Orton said. “Equities have been pushing higher in the context of a secular bull market and the two recent pullbacks have actually seen increased breadth with a strengthening technical backdrop. Earnings growth is largely behind the changes that we’re seeing, and there are some very positive developments that are taking place.”
For example, Orton noted that the number of companies with negative earnings growth has fallen according to both trailing and forward-looking measures. On consensus 12-month forward forecasts, just 9% of the S&P 500 Index’s companies are expected to have negative year-over-year earnings growth. This is the lowest since the end of 2018, before the COVID recession, and broadly in line with the range through much of the bull market of the 2010s.
“It is interesting to note that the proportion of S&P 500 stocks with negative earnings growth on a trailing basis peaked at 38% in August 2023,” Orton said. “Over the last 30 years it has only been higher in recessions. That fits with the idea that we’ve had rolling recessions through the economy and have already gone through an earnings recession in 2022 and early last year.”
With the rate-cutting cycle having just commenced, Orton pointed out that historically the S&P 500 has risen an average of 21% when there has been no recession in the 12 months after the start of Fed cuts. This time, he noted, we’re in a rare environment with earnings actually accelerating higher as rate cuts start.
Not surprisingly to Orton, small caps outperformed last week with the Russell 2000® Index now ahead of the S&P 500 by 434 bps quarter to date: up 9.10% versus 4.76%, respectively. The market of stocks, as represented by the S&P 500® Equal Weight Index, is also continuing to outperform: up 330 bps versus the cap-weighted S&P 500 quarter to date.
Market leadership is shifting...
Index returns:
Source: Bloomberg, as of 9/20/24.
With market leadership shifting, Orton believes there are opportunities for investors to consider leaning into these shifts. Orton has advocated for building better balance in portfolios for the past few months as the broadening in earnings growth eventually translates into rising prices across a broader range of stocks.
“We saw an inflection in the earnings for sectors like financials, healthcare, utilities, and real estate during the most recent earnings season while results across information technology remained strong,” he said.
The three top-performing sectors quarter to date are utilities, real estate, and financials, and Orton said he sees the combination of earnings growth and falling rates as well as other secular growth trends benefitting these parts of the market. While markets broadly have been supported by a continued move from money on the sidelines — U.S. equities last week had one of the biggest weekly inflows over the past few months– while long-only accounts are still sitting out. With rates at the front end of the yield curve coming down in a hurry, Orton believes investors may want to consider exploring the idea of considering putting cash to certain parts of the equity and fixed income markets dependent upon their individual situation.
With that in mind, Orton’s investment playbook is focused on a few key themes:
Consider the “AI 2.0” basket. Orton acknowledges that this point on artificial intelligence (AI) might sound like a broken record because the long-term growth opportunity is seen to be so attractive and prices have risen significantly. While the market might question the valuations and long-term winners and losers across the semiconductor and application software space, Orton said he thinks the infrastructure buildout plays remain on solid footing. He believes the capital expenditures arms race from the hyperscalers, which have committed to spending nearly $400 billion over the next two years, will benefit several different sectors and industries. For example, data centers are a $215 billion global market that grew 18% annually from 2018 to 2023. Orton said AI adoption is expected to accelerate data center growth as AI chips require three to four times more electrical power versus traditional central processing units (CPUs). This increases the need for companies that service the data centers, such as liquid cooling, and the need for more power. Orton has been bullish on electric utilities given rising power demand and the sector’s competitive yield. Just last week, a leading software and AI company announced a partnership to revive the Three Mile Island nuclear power plant exclusively to power its data centers. Orton said this is just a glimpse of what he expects to come as the U.S. is woefully behind modernizing its electrical grid to support the power required for the AI buildout.
Cybersecurity is an area of the market that has been unloved for a while but has recently accelerated. Orton believes cybersecurity stands to be a big beneficiary of AI as information technology budgets must increasingly address more sophisticated threats.
Tread carefully with commodities and commodity-sensitive stocks. Orton has long been skeptical of the commodity complex and hasn’t loved the energy or materials sectors, and he said their earnings growth justified that call. However, with macroeconomic sentiment still quite bearish and commodity allocations at 7-year lows, Orton said commodity-sensitive stocks could be more interesting to consider. If the U.S. economy does not fall into a recession, then Orton said energy stocks might look quite attractive at current levels. Additionally, commodities like copper are tied to many of the secular growth trends that are expected to benefit from the AI 2.0 theme. Overall, Orton believes commodities and commodity-sensitive equities are a natural contrarian trade and, given depressed price levels, he believes investors may want to consider exploring these asset classes for potential portfolio positioning.
What to make of small caps? The Russell 2000 is up 9.1% this quarter, but it has been a volatile ride. Orton believes the start of the rate-cutting cycle could be very supportive down the market-cap spectrum, and we’ve seen strong outperformance from small caps over large caps around rate cuts in the past. Additionally, he said the context of a soft landing coupled with high-yield spreads below their long-term average, a steepening yield curve, a weakening dollar, and falling inflation could be a Goldilocks setup for small caps. Orton noted that the Russell 2000 has made higher lows on each successive pullback, and the index is still nearly 10% from its all-time highs back in November 2021. The risk-reward looks favorable and small caps remain out of favor from a positioning standpoint, though Orton believes we are starting to see some green shoots with respect to inflows. Small cap earnings growth is also expected to finally inflect positively year-over-year at the end of 2024 before accelerating ahead of large caps in 2025.
Emerging markets. Orton continues to believe there is a constructive setup for emerging market (EM) equities with the worst fears around a global slowdown avoided. He said a weakening U.S. dollar benefits many emerging markets and should provide tailwinds going forward, and noted that emerging markets’ performance outside of China has been strong with the MSCI Emerging Markets ex-China Index up nearly 11% year to date. Within EM, Orton believes that India remains a favorable long-term opportunity for growth-oriented equity investors globally. While valuations remain an issue in India’s small-cap and mid-cap space, he sees the remarkable resilience of the NIFTY 50 in the context of the Indian government’s recent capital gains tax hikes as proof that Indian households now believe in the long-term equity story. Orton said any correction is likely to result in increased foreign buying given that global EM investors are underweight India despite its outperformance over the past two years.
“Coming off last week’s start of the interest-rate cutting cycle, we have plenty to look forward to with a plethora of central bank speakers,” Orton said. “Notably, Fed Chair Jerome Powell is set to give opening remarks on Thursday at the Treasury Market Conference.”
With market pricing suggesting another close call between a 25- and 50-basis point interest-rate cut in November, Orton said traders could be parsing comments closely as they look to firm up their bets. Friday’s release of the core Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred measure of inflation, should also help shape expectations.
“Outside of the U.S., the Swiss National Bank and Sweden’s Riksbank are expected to follow in the Fed’s footsteps and lower their respective policy rates, but with smaller 25-basis point reductions,” he said.
Orton believes we’ll also get some early indications of how inflation behaved in the euro-area and Japan this month with consumer price index data due from France, Spain, and Japan. A flurry of S&P Global Purchasing Managers Index (PMI) reports on Monday could add to the debate around the prospects for global growth.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 20, 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.
Link(s) are being provided for informational purposes only. Raymond James Investment Management is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James Investment Management is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.
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.
Emerging markets are generally smaller, less developed, less liquid and more volatile than the securities markets of the U.S. and other foreign developed markets. There are also risks of: greater political uncertainties; an economy’s dependence on revenues from particular commodities or on international aid or development assistance; currency transfer restrictions; a limited number of potential buyers for such securities; delays and disruptions in securities settlement procedures; less stringent, or a lack of, accounting, auditing, financial reporting and recordkeeping requirements or standards; and significant limitations on investor rights and recourse. The governments of emerging market countries may also be more unstable. There may be less publicly available information about issuers in emerging markets. When investing in emerging markets, the risks of investing in foreign securities are heightened.
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.
Definitions
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
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.
Contrarian investing is term used to describe the decisions of investors who intentionally go against prevailing market trends, buying when others sell, and selling when others buy.
The Personal Consumption Expenditures (PCE) Price Index, excluding food and energy, known as the core PCE index, is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index, released monthly by the U.S. Department of Commerce Bureau of Economic Analysis, is known for capturing inflation or deflation across a wide range of consumer expenses and reflecting changes in consumer behavior.
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.
Cyclical forces describe trends and changes in market conditions that occur as the economy passes through the business cycle’s stages of expansion, peak, recession, and recovery.
An earnings inflection marks a sudden change in the direction and rate of change of earnings growth. Earnings inflections can lead to either positive or negative change.
An earnings recession is considered to be two or more consecutive quarters of declining corporate year-over-year profits.
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.
Forward indicators use estimates of future activity to help forecast expected financial or economic outcomes over specific periods of time. A 12-month forward indicator consists of estimates looking one year into the future.
The France Consumer Price Index (CPI), published by the National Institute of Statistics and Economic Studies, is the instrument used to measure inflation. It allows the estimation of the average variation between two given periods in the prices of products consumed by households. It is based on the observation of a fixed basket of goods updated every year. Each product has a weight in the overall index that is proportional to its weight in household expenditure.
Front-loaded monetary policy describes a change in a central bank’s interest rate policy that is less gradual and more focused on reversing a previous policy course with a change that is more than minimal in scope and effect.
Fund flow is the net of all cash inflows and outflows into and out of a particular financial asset, sector, or index. It typically is measured on a quarterly or monthly basis. Investors and others look at the direction of fund flows for indications about the health of specific securities and sectors or the overall market.
Gross domestic product (GDP) is the total value of goods and services provided in an economy during a specified period, often one year.
Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
The Japan Consumer Price Index (CPI), released monthly by the Statistics Bureau of Japan, tracks core inflation by monitoring price changes in a wide variety of goods and services, excluding fresh foods but including energy, purchased by households nationwide.
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.
Oversold is a term used to describe a security or group of securities believed to be trading at a level below its or their intrinsic or fair value.
Investor positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
A real interest rate is an interest rate that has been adjusted to remove the effects of inflation. Once adjusted, it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor. A real interest rate reflects the rate of time preference for current goods over future goods. For an investment, a real interest rate is calculated as the difference between the nominal interest rate, which is not adjusted for inflation, and the inflation rate.
Risk assets refer to investments such as equities, commodities, high-yield bonds, real estate, and currencies, where the value may rise or fall due to fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.
Roll over, as it relates to investment returns, sector performance, or economic data, describes a widespread and unfavorable change in prices or data that begins slowly and picks up speed.
A rolling recession is an economic downturn that does not impact all parts of the economy equally or at the same time. It can be a recession that rolls through various sectors of the economy at different times.
S&P Global Purchasing Managers’ Index™ (PMI) surveys provide monthly indicators that track economic trends in more than 40 countries and regions, including the Eurozone.
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.
A “soft landing” occurs when a central bank adjusts interest rates to successfully reduce inflation and slow economic growth while avoiding a recession.
Spain’s Consumer Price Index, published by the National Statistics Institute, seeks to provide a statistical measurement of the evolution of the set of prices of goods and services that the resident population in family dwellings in Spain consumes. This index is compiled with nearly 210,000 prices reported by some 29,000 establishments distributed in 177 municipalities throughout the country. The data collection on 462 items is carried out in the traditional way (by personal visit to the establishments on the corresponding dates), as well as by telephone and e-mail. In addition, by automated means (such as scanner data or web scrapping), data is collected for another 493 items. For some tariffed items, information is obtained from the corresponding official publications.
The summary of economic projections is produced following meetings of the Federal Open Market Committee and includes meeting participants’ projections of the most likely outcomes for real gross domestic product growth, the unemployment rate, and inflation for a forward-looking three-year window and over the longer run.
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.
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.
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.
A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.
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 MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the United States and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to US citizens but not applicable to citizens in the overseas country.
The MSCI Emerging Markets® Index measures the performance of large and mid-cap stocks across 24 emerging markets (EM) countries.
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.
The Nasdaq 100 Index is a collection of the 100 largest, most actively traded companies listed on the Nasdaq stock exchange. The index includes companies from diverse industries like manufacturing, technology, healthcare, and others. The index excludes those in the financial sector, like commercial and investment banks.
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 PHLX Semiconductor Sector IndexTM (SOXTM) is a modified market capitalization-weighted index composed of companies primarily involved in the design, distribution, manufacture, and sale of semiconductors.
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-611154 Exp. 1/23/2025
The U.S. Federal Reserve’s messaging following its 50-basis point cut on Sept. 18 leaned marginally hawkish.
Chief Market Strategist Matt Orton, CFA, sees the larger cut as a sign that the Fed is taking the risks to the labor market very seriously, but not as a sign of an impending recession or heightened economic risk.
Orton expects the change to reduce some of the extreme sensitivity that has convulsed the market in response to every new economic data point in recent months.
There was no doubt that an interest rate cut was coming at the September meeting of the Federal Open Market Committee (FOMC), but the key questions heading into the meeting were around the size of the cut and the pace going forward. The U.S. Federal Reserve (Fed) ultimately kicked off its easing cycle with a super-sized 50-basis point (bp) rate cut, with Fed Chair Jerome Powell highlighting this as a risk management decision.1
There were limited surprises in the communication, said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. Still, he noted that the message leaned marginally hawkish — from Powell’s caginess over the cadence of future cuts in the press conference to some subtleties in the dot plot — versus what might have been expected in the context of an outsized rate cut to start the easing cycle. In particular, the median Fed official now sees 100 bps of cuts in 2024, but the distribution is skewed in a more hawkish direction for the year’s remaining two meetings. Nine policymakers view a cumulative 100 bps of cuts as appropriate in 2024, and one expects 125 bps. But seven favored just 75 bps total, and two wrote down only 50 bps. In short, 9 of 19 see either just one more 25-bp move or no cuts for the rest of this year. However, Orton’s base case puts Powell in the 100-bp camp and likely to steer the committee into two more 25-bp cuts this year.
After 420 days, the cutting cycle begins
U.S. 10-year Treasury yield since July 2023
Source: Bloomberg, as of 9/19/2024.
The Fed’s dot plots moved lower in September
FOMC member projections for the federal fund rate by year
Source: U.S. Federal Reserve, as of 9/18/24.
Here are some of Orton’s key takeaways from the September meeting:
This is absolutely a vote for the dual mandate. With inflation forecasts coming down, unemployment forecasts ticking up and a slight downgrade to gross domestic product (GDP) reflected in the summary of economic projections (SEP), Orton said this front-loaded cut is a risk management tool and shows the Fed is taking the risks to the labor market very seriously. That said, unless Fed officials become more concerned about the downside risks to the labor market, he said we should see a more measured pace of rate cuts going forward.
Orton does not think investors should read too much into this move as a harbinger of recession or heightened economic concern. Even after the cut, the real interest rate remains high and the Fed is taking advantage of the room it has to bring borrowing costs down. Plus, it has ample space to act more aggressively if labor market conditions continue to soften. “The Fed ‘put’ is alive and well,” Orton said.
This is a net positive for risk assets, he said, because it takes away some of the extreme sensitivity to each incoming economic data point we’ve been seeing over the past two months.
Orton has advocated for investors to consider building better balance in their portfolios, and the Fed’s 50-bp move increases his conviction in that call. That doesn’t mean ditching the mega-caps, he said. Rather, it means maybe taking some potential profits where portfolio positions have become very overweight or considering whether to use cash to explore adding exposure in cyclical and rate-sensitive areas of the market like industrials, utilities, real estate, and smaller-cap companies. He said investors also should resist chasing the market higher and consider using downside opportunistically to consider adding exposure appropriately.
“Overall, with a backdrop of already loose financial conditions, now further supported by the Fed, as well as low near-term recession risk, I remain optimistic in my view for risk assets going forward,” Orton said. “We’ve also seen some adjustment in the rates market with respect to the Fed cutting cycle, and while the market might still be ahead of my base case for two more cuts in 2024 and four in 2025 (all 25 bps), we’re closer now than we have been for a while, which should also help to reduce sharp market reactions to any convergence that takes place between the market’s interest rate expectations and what actually happens.”
Interest rate expectations fall after the first cut, but are still optimistic
Futures-implied 25-basis point cuts priced in by FOMC meeting
Source: Bloomberg, as of 9/18/24.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 18, 2024.
M-609820 Exp. 1/19/2025
A pessimistic market narrative has overshadowed better than expected second-quarter S&P 500 Index earnings, which were underscored by an expansion in earnings breadth.
The S&P 493 — the S&P 500 excluding the Magnificent Seven — finally flipped back to positive earnings growth in the second quarter after five quarters in the red.
The ride higher is likely to be bumpy, but volatility can provide an opportunity for selective investors to consider exploring positions across sectors and down the market-cap spectrum.
Investors are constantly saturated with an overwhelming amount of information. While all information matters, we believe some data points are more relevant than others, and frequently the importance of each data point depends on the macroeconomic backdrop and prevailing market narrative.
That said, we are prepared to argue that over the long term there are a few critical pieces of information that play an outsized role in driving market performance — and one of those critical pieces of information is earnings growth. For the long-term investor, we see earnings as the north star to guide multi-year decisions.
Today, the S&P 500 Index finds itself flirting with fresh all-time highs yet again,1 and with no shortage of catalysts on the board, amid calls for another correction, our message is: Let earnings be your north star. We regard earnings as the ultimate arbiter of performance, and the just-concluded and better-than-expected earnings season is getting largely ignored in favor of the prevailing pessimism driving the market narrative. Second-quarter S&P 500 earnings per share (EPS) growth came in at 11.4%, beating the consensus estimate of 8.8%. This was the highest year-over-year earnings growth in 10 quarters, or since the 31.4% EPS growth in the fourth quarter of 2021.
Earnings and performance
S&P 500 Index vs. forward EPS
Source: Bloomberg, as of 9/17/2024.
Over the past couple of years, the market narrative has understandably been dominated by increasing concentration and multiple expansion as earnings growth slowed across most sectors and industries. Consequently, the S&P 500 has morphed into a top-heavy index with earnings and performance driven by an exclusive cohort of mega-cap technology names — the Magnificent Seven — whose blistering performance and robust earnings growth elevated the headline index numbers while concealing most of the index constituents’ lackluster earnings growth and returns. The dominance of the mega-caps continues to persist: if you exclude NVIDIA from second-quarter’s earnings, the EPS growth of the information technology sector would fall from 20.3% to 9.9%; that makes NVIDIA responsible for about 51% of information technology’s EPS growth during the quarter. Similarly, if you exclude Amazon from the consumer discretionary sector, the sector’s EPS growth flips to a 2.6% decline from a 12.9% gain. Altogether, the Magnificent Seven are responsible for 52.4% of the overall index’s EPS growth during the second quarter. The index is still incredibly reliant on these massive companies. But we’re finally starting to see the rest of the market contribute to earnings growth, and the trend continues to move in the right direction.
S&P 493 posts first quarter of EPS growth since the fourth quarter of 2022
Quarterly year-over-year EPS growth rates over the last two years
Source: FactSet, as of 9/17/2024.
In fact, the S&P 493 — the S&P 500 excluding the Magnificent Seven — finally flipped back to positive earnings growth in the second quarter after five quarters in the red. It’s also encouraging that we’re seeing more sectors drive the increase in earnings growth as earnings breadth expands both down the market-cap spectrum and across sectors. Only two sectors posted negative EPS growth — industrials and materials — while every other sector contributed positively to the index’s EPS growth, a stark contrast to last year. Five sectors posted second-quarter EPS growth that outpaced the broader index: utilities, information technology, financials, healthcare, and consumer discretionary. Seven of the 11 sectors posted earnings growth ahead of pre-season estimates as well. And 395 companies beat their EPS expectations. That’s 79% of companies, which is above the 5- and 10-year averages of 77% and 74%, respectively. Healthcare, real estate, and industrials had the highest percentage of EPS beats at 87%, 84%, and 83%, respectively. We believe now is a good time for investors to consider their portfolios with an eye on opportunities to rebalance positions in an effort to benefit from any continuation of this expansion in earnings breadth.
It’s not just tech anymore
Sector contribution to S&P 500’s second-quarter earnings growth
Source: FactSet, as of 9/17/2024.
In addition to the general earnings trends, here are some key takeaways that we believe accurately reflect the totality of economic reports, management commentaries, and deeper dives into company-specific reports:
The economy is slowing, not crashing into recession. Negative corporate earnings and guidance typically precede a recession, and that just hasn’t been what we’ve seen. Of the 109 companies that provided third-quarter EPS estimates, only 54% were negative, below the 5- and 10-year averages of 59% and 63%, respectively. Additionally, according to Bloomberg, there were roughly 629 mentions of the word “recession” (including synonyms) in second-quarter S&P 500 earnings call transcripts. That’s down from 1,609 mentions in the second quarter of 2023, and down from 1,729 mentions in the second quarter of 2022. Consensus expectations are currently for 4.9% earnings growth in the third quarter of 2024 and 15.4% in the fourth quarter, respectively, bringing the earnings growth for the full year to a very solid 10.2%. The second quarter’s earnings, guidance, and management sentiment don’t point to an impending recession. Our conclusion is to look past the headlines and listen to what this earnings season is saying.
The consumer is doing all right. Despite prevailing market narratives, the American consumer is showing resilience. Consumers in aggregate have continued spending ahead of expectations and second-quarter earnings helped add some color to this story. Management commentary across second-quarter earnings gives us two main insights about the nuanced consumer. First, consumers are seemingly more discerning and increasingly focused on value. They are deferring bigger projects and spending in anticipation of lower interest rates and trading down on goods and services wherever they can (e.g., “Maybe I don’t need an $8 Frappuccino® this morning”). Second, we’re not dealing with a population of consumers who all make the same decisions. Instead, we’re dealing with consumers who appear generally to fall into two distinct groups. Higher-income consumers are largely maintaining the same rate of spending while lower-income consumers are having to cut back more on discretionary purchases. While their pace of spending has slowed, it’s not falling off a cliff like analysts and pundits feared, and the prospect of falling interest rates should bolster spending and alleviate some of the pent-up consumer demand for larger purchases such as autos.
Expect the artificial intelligence (AI) build-out to continue for the foreseeable future. The AI trade has simultaneously been both the most praised and the most scrutinized trade over the past year. This earnings season, investors were looking for the companies that are investing the most into the AI infrastructure — the hyperscalers — to justify their spending and give more color around the return on investment (ROI) on the hundreds of billions in spent and pledged capital expenditures (capex). For now, we believe investors should view the hyperscalers’ capex as strategic long-term investments into the AI arms race as companies are still largely avoiding providing granular ROI numbers. The real takeaway from the second quarter is that the capex spending is expected to persist for the foreseeable future, which gives a lot more revenue visibility to the chip designers, semiconductor capital equipment manufacturers, and data-center servicers that have been the biggest beneficiaries of the AI megatrend. All the hyperscalers maintained or raised their capex guidance in the second quarter, confirming their continued plans to invest in excess of $400 billion over the next two years alone. Separately, investors got to hear from companies across non-tech sectors (e.g., consumer staples) tout their cost savings and efficiency gains as a result of implementing AI into their processes. We believe this trade hasn’t reached its end, and investors with a time horizon in excess of five years would do well not to miss out on this intra-generational megatrend.
Earnings growth broadly exceeded expectations
Second-quarter S&P 500 sector EPS growth vs. consensus pre-season estimates
Source: FactSet, as of 9/17/2024.
Overall, it’s critical to stay focused on what really matters. And while the prevailing narrative may have found reasons to quibble with earnings from the mega-cap complex, our takeaway is still one of optimism following a very constructive earnings season for equities. Yes, we’re at or near all-time highs, but our conclu-sion is that earnings and forward growth justify our being here. Going forward, investors should consider focusing on building balance in their portfolios. The ride higher is likely a bumpy one, but volatility can provide an opportunity for selective investors to consider exploring positions across sectors and down market cap. We see reasons to expect a continuation of the earnings breadth expansion over the next few quarters and also to expect that expansion to be the catalyst that permits the average stock to continue picking up relative performance against the Magnificent Seven.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 17, 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
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.
Concentration is a term used to describe the extent to which investments in a portfolio, group of portfolios, industry, sector, index, or particular geography or clustered in groups that share specific factors or other characteristics.
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.
Forward earnings per share is an estimate for the next period’s earnings per share for a company’s or group of companies’ profit divided by the outstanding shares of the company’s or group’s common stock.
Guidance refers statements from the managers of publicly traded companies that indicate whether they expect to realize near-term profits or losses and why.
Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
A megatrend is a widespread and long-term macroeconomic, technological, social, environmental, political, or other change that may develop slowly at first but that has a major, ongoing impact once it gets underway. Megatrends are distinct from smaller trends in business, economic, or other spheres of activity that have less far-reaching or enduring effects.
A multiple, sometimes referred to as the price multiple or earnings multiple, is a measure of a company’s value based on the ratio of its current share price to its earnings per share. This ratio is known as the price-to-earnings ratio, or P/E.
Next 12 months earnings per share (EPS) uses the forward earnings per share calculation to look at the period from the present to 12 months into the future. Forward earnings per share is an estimate for the next period’s earnings per share for a company’s profit divided by the outstanding shares of its common stock.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
Return on investment (ROI) is a performance measure used to assess the profitability or efficiency of an investment, or to compare more than one investment. It is calculated by dividing the benefit or return of the investment by its cost and expressing the result as a ratio.
Visibility reflects the degree to which a company’s management or the analysts who follow a company or a particular industry or sector of the economy can reliably estimate future near- or long-term performance.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
M-609036 Exp. 1/17/2025
We know an interest rate cut is coming at the Federal Open Market Committee (FOMC) meeting on Sept. 18, but by how much and what will be the path going forward?
We know the economy is slowing, but have real rates been elevated for so long that the economy will slow into a recession?
We know that technology earnings are normalizing, but will the increase in earnings breadth across other sectors be enough to pick up the slack?
These are a few of the questions that have dominated the market narrative since early August, fueling volatility in what had been an otherwise calm year.
“Markets hate uncertainty,” said Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management. “Unfortunately, I don’t think we’re going to get too many answers this week at the September FOMC meeting.”
Fixed income markets are already pricing in a benchmark federal funds rate of 2.75% at the end of 2025, representing 10 rate cuts between now and the end of next year.1
“That seems overly dramatic given economic data that I continue to believe is consistent with a slowdown, not a recession,” Orton said. While hiring over the past few months has been weaker than expected, we’re still not seeing significant layoffs. At the same time, he said corporate margins remain quite strong and small business optimism is off the lows from earlier this year.
Critically, Orton said, earnings continue to improve across a wider range of sectors, including financials, healthcare, materials, utilities, and real estate. The average stock also continues to perform well, with the S&P 500® Equal Weight Index and the Russell 2000® Index outperforming the cap-weighted S&P 500 Index by 3.28% and 3.53%, respectively, quarter to date (up 6.61% and 6.86% versus 3.33%). Technology regained some footing last week, another encouraging sign if the trend holds. Orton remains optimistic about the path forward for the market but cautions against chasing rising prices.
It’s not just tech anymore
Sector contribution to S&P 500’s second-quarter earnings growth
Source: FactSet, as of 9/13/24.
“Remember, just two weeks ago we had the worst week since March 2023, and last week was the best since the start of the recent rally in November 2023,” he said. “With uncertainty here to stay for the foreseeable future, we’re very likely to see more drawdowns, and investors should stand ready to consider using that downside opportunistically. That could include thinking about putting cash to work and leaning into a market if it supports increased breadth going forward.”
Looking at the main event this week, Orton said he is not sure the market will get the kind of clarity it seems to expect with respect to the rate-cutting cycle. Last-minute media reports alluding to the potential for a 50-basis point (bp) cut makes a smaller 25-bp move — which is still Orton’s base case — a more significant volatility event. He expects the FOMC dot plot for 2024 to shift down with the median participant forecasting three 25-bp cuts, compared with a one-cut median at the time of the July meeting. But he said that will be conditioned on the labor market not showing clearer signs of deterioration. Should signs of undesired labor-market weakness emerge in the months ahead, there is a low bar for the FOMC to quicken the pace of cutting to reach a neutral rate more expeditiously. While the market could have some indigestion from “only” a 25-bp cut, Orton expects “very dovish” messaging from U.S. Federal Reserve (Fed) Chair Jerome Powell, which might blunt any over-reaction in the market.
While the trajectory of the Fed is important, Orton said it does not change the underlying fundamentals that are allowing equities to ultimately move higher. Earnings have been good, and he said he is encouraged that the broadening of earnings growth that has taken place over the past few quarters is continuing and finally translating to rising prices across a broader range of stocks. Utilities and financials are both outperforming the S&P 500 year to date, joining information technology and communication services. We’re also seeing much-improved performance across healthcare, industrials, and real estate. S&P 500 earnings per share (EPS) growth expectations for 2025 now sit at 15.4%, hardly indicative of a massive slowdown. Guidance from management teams has been positive despite some signs of slowing economic growth, and Orton said it also looks like small-cap earnings might finally be nearing an inflection point. Certainly, he said, there are risks should we start to see damage to the labor market. But for now, with the broader market finally working alongside the mega-cap stocks, which look to have found some footing, he believes the market can continue to push higher.
“Selectivity will be critical given the risks that exist,” Orton said, “but that’s yet another reason for investors to think about building better balance in their portfolios.”
Building more balanced portfolios has been a focus for Orton since the start of the third quarter, and he continues to expect to see a more balanced market going forward. Since the S&P 500 peaked on July 16, the Magnificent Seven have mostly slumped, with the Bloomberg Magnificent 7 Total Return Index down -5.3%. Due to their large weighting in the index, the S&P 500 is down -0.5% in that time, yet the S&P 500 equal-weighted index is up 2.0% over the same period. Many skeptics have highlighted that some of the leading sectors like utilities and real estate have been aided by expectations for monetary policy easing. That’s true, Orton said, but it’s also a testament to the improving outlook for profits across these sectors and the rest of the market.
“Balance also doesn’t mean abandoning the market leaders of the past few years,” he said. “Instead, it means balancing weights and considering leaning into the more cyclical parts of the market that I believe should benefit in a non-recessionary and lower-rate environment. There remain some attractive opportunities. Just remember not to chase trades, even in weeks like we just had.”
With that in mind, Orton’s investment playbook is focused on a few key themes:
Consider AI 2.0. The price action across artificial intelligence (AI) stocks and proxies last week was encouraging and he thinks it highlights that buyers are more than willing to step in when fundamentals get dislocated from price. The hyperscalers continue to spend hundreds of billions of dollars, and there is strong visibility in the earnings for a number of AI infrastructure companies. Take data centers, which are a $215 billion global market that grew 18% annually from 2018 to 2023. AI adoption is expected to accelerate data center growth as AI chips require three to four times more electrical power versus traditional central processing units (CPUs). This increases the need for companies that service the data centers (e.g., liquid cooling) as well as the need for more power. Consequently, Orton has been bullish on electric utilities given the rising power demand and the sector’s competitive yield. He believes utilities also are an attractive hedge, which is important heading given that volatility is likely to stay elevated through elections. The AI 2.0 theme provides a way to consider getting exposure to the buildout of AI without having to add exposure to the traditional semiconductor and software plays that are more richly valued, he said.
What to make of small caps? Small-cap equities are now up nearly 9% year to date, with the Russell 2000 up 8.7%, but it has been a volatile ride. Orton doesn’t expect a smooth path higher, but does see scope for small caps to outperform, especially if we get more dovish messaging from the Fed. The Russell 2000 has made higher lows on each successive pullback, and the index is still more than 10% from its all-time highs back in November 2021. The risk-reward looks favorable in a soft-landing scenario, he said, and small caps remain out of favor from a positioning standpoint. Small-cap earnings growth also is expected to inflect positively year over year at the end of 2024 before accelerating ahead of large caps in 2025.
Potential opportunities in emerging markets (EM) and Europe, Australasia, and the Far East (EAFE). As yields and the U.S. dollar move lower, there are meaningful implications globally. EM equities are key beneficiaries of a lower dollar, and Orton said we’re likely to see weakness continue as the United States finally converges with the rest of the world’s central banks in starting its rate-cutting cycle. There might be some volatility in the short term as the dollar reacts to market pricing of the depth and pace of rate-cut pricing, but he said the path looks lower. China remains a big risk and it’s an area that Orton said he would avoid. China’s activity data continues to show signs of weakness, with:
Industrial production slowing to a five-month low of 4.5% year on year (with a consensus estimate of 4.7%),
Fixed asset investment growth year to date fading to 3.4% year on year (consensus: 3.5%), and
Nominal retail sales growth decelerating to a two-month low of 2.1% year on year (consensus: 2.5%). Meanwhile, the decline in home prices accelerated: New home prices were down 0.73% month on month, and used home prices were down 0.95%.
“Consequently, I still favor EM ex-China with India remaining my most preferred EM as the NIFTY 50 Index continues to push to all-time highs,” Orton said. “There are also opportunities in international developed markets, but being selective is critical.” The European Central Bank last week cut rates again (following a cut in June) after recent data highlighted the case that inflation has continued to move lower, though Orton expects the pace forward for further cuts likely will be gradual. European financials have recovered nicely, and this is an area that he thinks looks interesting heading into year-end.
All eyes are on the Fed this week, as the FOMC is widely expected to cut interest rates for the first time since 2020, converging with other major central banks that have already started the rate-cutting process. Along with the size of the cut, the focus will be how the median dot in the FOMC’s dot plot evolves and where the long-run dot goes.
The Bank of England and the Bank of Japan also will issue policy decisions.
On the economic front, we’ll get updates on U.S. retail sales and industrial production for August.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 13, 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.
Link(s) are being provided for informational purposes only. Raymond James Investment Management is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James Investment Management is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks.
International investing presents specific risks, such as currency fluctuations, differences in financial accounting standards, and potential political and economic instability. These risks are further accentuated in emerging market countries where risks can also include possible economic dependency on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, and liquidity risks related to lower trading volumes.
Definitions
Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
Breadth describes the relationship between the median and the mean of a market index. When a few data outliers result in a mean that is substantially larger (or smaller) than the median of the full data set, then the performance of the entire index is being driven by a “narrow” selection of companies. An index supported by “broad” market movements is one where the median is closer to the mean.
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.
The dot plot is a chart summarizing the Federal Open Market Committee’s (FOMC) outlook for the federal funds rate. Each dot represents the interest rate forecasted by one of the 12 members of the committee.
Dovish, hawkish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Centrists tend to occupy the middle of the continuum between tight (hawkish) and loose (dovish) monetary policy.
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.
An earnings inflection marks a sudden change in the direction and rate of change of earnings growth. Earnings inflections can lead to either positive or negative change.
The federal funds rate, known as the fed 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.
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.
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.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
The neutral rate is the theoretical federal funds rate at which the stance of U.S. Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability.
Nominal measures of economic activity such as price trends or gross domestic product include all economic activity and are often referred to as headline measures. Real measures of economic activity are adjusted for inflation, in some cases by excluding more volatile prices for things like food and fuel.
Positioning refers to assessments of whether professional investors are, on the whole, bullish or bearish on a particular security, industry, sector, market capitalization or other area of the market, as reflected by the extent to which they are invested in the area of the market in question.
A real interest rate is an interest rate that has been adjusted to remove the effects of inflation. Once adjusted, it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor. A real interest rate reflects the rate of time preference for current goods over future goods. For an investment, a real interest rate is calculated as the difference between the nominal interest rate, which is not adjusted for inflation, and the inflation rate.
A “soft landing” occurs when a central bank adjusts interest rates to successfully reduce inflation and slow economic growth while avoiding a recession.
Visibility reflects the degree to which a company’s management or the analysts who follow a company or a particular industry or sector of the economy can reliably estimate future near- or long-term performance.
Indices
The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 80% of the investable U.S. equity market.
The 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 Bloomberg Magnificent 7 Total Return Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of seven widely traded companies classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).
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.
“Bloomberg®” and the Bloomberg Magnificent 7 Total Return Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Raymond James Investment Management. Bloomberg is not affiliated with Raymond James Investment Management, and Bloomberg does not approve, endorse, review, or recommend Raymond James Investment Management’s Markets in Focus. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to Raymond James Investment Management’s Markets in Focus.
>M-607365 Exp. 1/16/2025
The S&P 500 Index experienced its worst week in over a year, but don’t let that cloud your view of its year-to-date performance.
Markets are expected to be more sensitive to new economic data during the U.S. Federal Reserve’s communications blackout period.
Softer than expected jobs data left the path for interest rates little changed; expectations are leaning in favor of a 25 basis point (bp) cut in September rather than a 50 bp cut.
Although defensive stocks are performing well due to ongoing macroeconomic angst, their delayed improvements in performance are an argument for building balanced portfolios.
Last week was the S&P 500 Index’s worst week in over a year, triggering a flurry of negative headlines.1 “With so much pessimism around, it’s important to take a step back and consider the greater context,” said Joey Del Guercio, Research Associate for Market Strategy at Raymond James Investment Management.
After its poor week of performance, the S&P 500 was still up 14.48% year to date.
“While it’s true that last week was the S&P 500 Index’s worst week since March of 2023, it just came off eight consecutive days of green amid a torrid rally off the last economic scare and the unwinding of the yen carry trade,” Del Guercio said.
The S&P 500® Equal Weight Index outperformed the S&P 500 Index, its capitalization-weighted counterpart, by 1.10% last week. It also outperformed the S&P 500 by 20 basis points (bps) since the drawdown on Aug. 5, and it has outperformed by 4.47% quarter to date. “This expanding market breadth underscores the importance of selectivity in the current environment,” Del Guercio said.
Last week, which was shortened by the Labor Day holiday, investors paid close attention to a slew of economic data: the Job Openings and Labor Turnover Survey (JOLTS), the ADP® National Employment Report™, and the Employment Situation Summary.
There’s plenty to be positive about
Index quarter-to-date returns
Source: Bloomberg, as of 9/6/24.
The Employment Situation Summary showed total nonfarm payrolls increasing by 142,000 month over month, which was less than the consensus estimates of 165,000. The unemployment rate lowered to 4.2% from last month’s 4.3%, which was in line with expectations.
The U.S. Federal Reserve (Fed) is now in the blackout period ahead of its September Federal Open Market Committee (FOMC) meeting, and markets are convinced that it will deliver a rate cut. Del Guercio said that the August jobs report still left up in the air whether the Fed will decide on a 25-bp cut or a more accommodative 50-bp cut.
“The report was likely just good enough for the Fed to favor a 25-bp cut in September,” Del Guercio said. “Furthermore, Fed board member Christopher Waller’s speech on Friday suggested that he was leaning towards the 25-bp cut despite his statement about remaining open-minded.”
Del Guercio said that he doesn’t think the story has changed much. “The labor market is weakening, not breaking, and we’re likely to see increased volatility around data releases,” he said. Rate cut expectations have ticked down for September, but they increased for November and December. Del Guercio said that he believes the expectations for big rate cuts look even more overdone. “The base case remains for three successive 25-bp cuts, with September’s cut being a practical certainty.”
Last week, the only sector showing a positive return was consumer staples (+0.66%), while utilities and real estate were down -0.10% and -0.34%, respectively. Every other sector was down more than -2%. Five sectors posted drops of more than -4%, led by technology declining -7.15%.
Utilities have been the year’s strongest-performing sector, up +22% year to date, followed by financials up +19% and consumer staples up +18%. Technology and communications stocks are still outperforming the S&P 500 Index year to date, but their outperformance continues to wane.
“Earnings season is effectively over, and the main takeaway is that it’s not just the Magnificent Seven anymore,” Del Guercio said. “Earnings breadth has broadened out. More than 80% of S&P 500 Index companies beat their earnings per share (EPS) growth estimates.” At least 70% of the constituents in each sector beat their EPS growth estimates.
Del Guercio said that the technology sector may still be the biggest contributor to overall index earnings growth, but financials are a close second, followed by healthcare. “This earnings season has not suggested a recession: earnings growth has been robust, margins are holding up, and guidance has been positive.”
Despite repeated declarations of their demise, consumers are also broadly holding up. “The consumer’s story continues to be a bifurcated one where higher income consumers — who account for the majority of spending — are basically unfazed while lower income consumers are deteriorating,” Del Guercio said.
“The outperformance of defensive stocks is partially attributable to the macroeconomic angst we’re continuously reminded of, but it’s also an argument for having balance in your portfolio,” he said.
Del Guercio has repeatedly said to expect volatility, have a shopping list, and be opportunistic. “The ongoing rotation is an opportunity worth considering that investors shouldn’t ignore,” he said. “Mega-cap tech isn’t the only game in town any more, and the case for building balance across portfolios is even stronger.” Del Guercio said that investors should use the anticipated September seasonality to consider exploring areas that could be this rotation’s potential beneficiaries:
Bond proxies. Del Guercio is optimistic about real estate and utilities. “These sectors are ‘bond proxies’ because they have higher yields and relatively low volatility, like a bond.” Lower interest rates may present tailwinds for the sectors because (1) lower rates could help finance more projects, and (2) risk-averse investors, looking for yield, may leave lower-interest money market funds to invest in these sectors. “Utilities have an additional tailwind from the U.S. demand for electricity accelerating, due to artificial intelligence (AI) enthusiasm, after decades of stagnation,” he said.
No, the AI trade is not over. It makes for a good headline, but Del Guercio said he doesn’t think it’s time to pump the brakes on investing in AI infrastructure. “In my opinion, the near-term perceived risks of overinvestment are overblown,” he said. “The companies spending hundreds of billions are the only ones who really can afford to. AI is a platform shift similar to the iPhone.” Besides chip designers, Del Guercio said that electronic design automation providers look attractive. They could benefit from increased chip complexity and a growing number of use cases alongside new entrants into the chip design space.“ Outside of tech, there are plenty of opportunities in industrials with companies providing services, like liquid cooling, to the hyperscalers and their datacenters.”
Big opportunity for small caps. Investors have been painfully aware of the relatively disappointing performance of small-cap stocks over the past few years, but Del Guercio said that things are looking up for smaller market cap companies. “The Russell 2000® Index is outperforming the S&P 500 Index by around 3% quarter to date, and there’s a solid argument for the outperformance to continue,” he said. The Russell 2000 Index is still 15% from its all-time high in 2021, compared to the S&P 500 Index being around 5% from its all-time high in July of this year. “Small-cap earnings growth is also expected to finally inflect positive, year over year, at the end of 2024 before accelerating ahead of large caps in 2025,” Del Guercio said. He added that small caps also stand to benefit from a continuation of the “soft landing” narrative.
Traders will use this week’s incoming data to finalize their interest rate bets while the Fed is in its blackout period. Two main releases to monitor will be the Consumer Price Index (CPI) on Wednesday and Producer Price Index on Thursday. Del Guercio said he doesn’t expect much volatility around these prints unless they are miserable. The National Federation of Independent Business Index of Small Business Optimism will come out on Tuesday, and the University of Michigan Index of Consumer Sentiment comes out on Friday. Overseas, the U.K. Office for National Statistics will release gross domestic product (GDP) figures and Labour Market Overview data ahead of the European Central Bank’s monetary policy meeting.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of September 6, 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.
Link(s) are being provided for informational purposes only. Raymond James Investment Management is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James Investment Management is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.
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.
Real estate investments can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks to real estate investments.
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%.
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 carry trade involves borrowing money in countries where interest rates are low and using the funds to make investments in countries with high interest rates.
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. Headline readings of CPI inflation, also known as nominal CPI inflation, include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index.
Defensive stocks are companies that tend to have a constant demand for their products or services, making their operations more stable during different phases of the business cycle.
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.
Electronic design automation (EAD) services provide software tools to designing electronic systems, including integrated circuits and printed circuit boards.
The Employment Situation Summary, also known as the payroll report, is a monthly U.S. Bureau of Labor Statistics 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 Federal Open Market Committee (FOMC) consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth. The FOMC observes a blackout period, which begins at midnight of the second Saturday before each meeting. During the blackout periods, committee members do not make public comments about macroeconomic developments or monetary policy issues.
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 “hard landing” occurs when a central bank’s unsuccessful management of interest rates causes a recession.
Hyperscaler refers to the largest cloud computing providers that can provide massive amounts of computing resources and storage at enterprise scale.
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.
Labour Market Overview data is published by the U.K. Office for National Statistics to provide estimates of employment, unemployment, economic inactivity and other employment-related statistics for the UK.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
The National Federation of Independent Business Index of Small Business Optimism consists of 10 equally weighted and seasonally adjusted variables. The monthly change of each variable contributes proportionally to the overall monthly change in the index.
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 bond proxy is a term used to describe equity shares are other securities that provide comparably predictable levels of return to bonds. Bond proxies include dividend-paying stocks, including those in industries with more predictable revenue streams such as utilities and consumer staples.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
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 adjusts interest rates to successfully reduce inflation and slow economic growth while avoiding a recession.
Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.
The U.K. Office for National Statistics publishes gross domestic product (GDP) estimates as the main measure of U.K. economic growth based on the value of goods and services produced during a given period.
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 Nasdaq 100® is a stock market index made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index.
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-604596 Exp. 1/9/2025
Earnings breadth has continued to expand with sectors like financials, healthcare, utilities, and consumer discretionary increasingly contributing to growth alongside information technology.
The labor market is key to sustaining current market momentum. The path forward is unlikely to be a straight line, especially with this week’s focus on a slew of public and private jobs data.
Areas to consider: Small and mid caps. The capital expenditure beneficiaries of artificial intelligence. Fixed income. Select global markets.
September might be the S&P 500 Index’s most challenging month historically, but the market heads into this seasonally weak period with tailwinds that keep Matt Orton, CFA, Chief Market Strategist at Raymond James Investment Management, optimistic on the longer-term outlook.1
With earnings season largely complete, the S&P 500’s second-quarter earnings growth stands at 11.4%, well ahead of expectations, and with generally positive guidance going forward. Critically, Orton said, the reliance on a handful of mega-cap technology companies to deliver profit growth is fading. Earnings breadth has continued to expand with sectors like financials, healthcare, utilities, and consumer discretionary increasingly contributing to growth alongside information technology. And now that quarterly results from the leading designer of artificial intelligence (AI) chips are out of the way, Orton said anxiety around the AI trade and concerns around the capital expenditures cycle can take a bit of a breather.
“We’re seeing the increase in earnings breadth finally start translating to an increase in price breadth, and I believe this can continue going forward,” he said. “Not only are we seeing better performance across market capitalizations, but international developed markets are back at all-time highs while India’s NIFTY 50 Index late last week posted its longest winning streak ever. The path forward is unlikely to be a straight line, especially with a slew of jobs data in focus this week, but I believe investors should consider using downside opportunistically to build better balance in portfolios.”
S&P 500 second-quarter earnings growth by sector
(as of 8/30/2024)
Source: Bloomberg, as of 8/30/24. The numbers in parentheses indicate the number of companies that have reported second-quarter earnings so far, followed by the total number of companies in each category.
This week is all about U.S. data with the August payrolls release out on Friday, preceded by the Services ISM® Report on Business®, the ADP® National Employment Report™, and the Job Openings and Labor Turnover Survey (JOLTS).
“It’s worth noting that most of the data that has come out following July’s surprisingly weak payroll release has been constructive and certainly doesn’t paint the picture of an economy heading for recession,” Orton said. Recent jobless claims data makes the July payrolls data seem more like an aberration, while last week’s consumer spending figures signaled some resilience and better than expected positive momentum heading into the third quarter.
“I’ve long contended that American consumers are in better shape than the prevailing market narrative,” he said. Certainly, more affluent consumers are spending more robustly than lower-income consumers, but he said overall consumers are simply becoming more discerning in their purchases, not retrenching. The labor market is the key to sustaining this momentum, and Orton expects labor and activity data to show additional signs of resilience, which will push back against the perceived need for the 50-basis point interest rate cut that is currently priced into the market.
“That said, I believe U.S. Federal Reserve Chair Jerome Powell has signaled a low bar for an accelerated pace of cuts,” Orton said. “If payrolls and the unemployment rate show the wrong mix of unwanted deterioration, he likely could coax cautious Federal Open Market Committee holdouts to support such a move based on risk-management concerns.”
While Orton thinks the market is too aggressive in its pricing of the rate-cutting cycle, he said that’s not a reason to stay out of the market. He believes far too many narratives have been bearish about the economy. Now he sees the narrative as too bearish as it mostly holds that the economy needs aggressive cuts to avoid a hard landing and that the Federal Reserve (Fed) is too short-sighted to see through the recent data.
“The former view has been wrong for the past two years, and the latter view is simply an extension of misplaced bearishness,” he said. “Even if there is some volatility around normalizing the pace and depth of rate cuts priced into the market, that doesn’t mean stocks are suddenly viewed as being more expensive, particularly companies in the technology sector.”
If anything, Orton said any adjustments to the discount rate will probably be a wash when contextualized with earnings and guidance that continue to exceed expectations. He said he also would bear in mind we’re starting the rate-cutting cycle at a time when financial conditions are already quite loose, which supports growth.
Markets pushed higher last month despite a surge in volatility from a confluence of technically driven factors, economic concerns, and some critical earnings reports. What’s key to notice, Orton said, was some change in the composition of market leadership during the recovery, with healthcare and financials the top two sectors contributing to August performance. The average stock is sitting at new highs with the S&P 500® Equal-Weighted Index finally starting to outperform. But he said that doesn’t mean investors should abandon what has been working: Information technology rounded out the top three contributors to S&P 500 gains for August. Instead, he favors considering starting to lower concentration levels in portfolios and thinking about gradually leaning into the broadening market.
“September or not, we should be encouraged by the longer-term tailwinds,” Orton said, noting that the market trend is still positive and that positive momentum is expanding. Overseas, the MSCI EAFE® (Net) Index broke out to levels that it previously failed to overtake in 2021 and 2007. Orton believes there are still plenty of opportunities in this market, and investors may want to consider using any September downside to evaluate their portfolios during these downside opportunities. Accordingly, his investment playbook highlights four key themes:
Consider adding exposure down the market-cap spectrum: Small caps have been the perennial laggard over the past few years, but Orton has been increasingly constructive as financial conditions have eased and earnings look to be approaching an inflection point. The Russell 2000® Index has outperformed the S&P 500 by nearly 5% quarter to date (up 8.51% versus 3.67%, as of Aug. 30, 2024), and Orton said there is scope for this to continue if the economic narrative holds up while interest rates continue to move lower. With large caps pushing back through all-time highs, the Russell 2000 remains about 10% below its all-time high from July 2021. Earnings season was constructive with an improvement in companies posting results that exceeded expectations and management guidance generally holding up, he said. Orton also noted that mid-cap performance has been close to the S&P 500 Equal-Weighted Index as breadth has expanded. “I believe there is certainly opportunity down market-cap with a favorable risk-reward given historic valuation discounts and improving fundamentals,” he said.
Building balance doesn’t mean ignoring the mega-caps: “All too often I hear rotation portrayed as a zero-sum game, where the broader market can only do well at the expense of the mega-caps,” Orton said. “That narrow and reductive perspective leaves a lot of value on the table, ignoring the size of the cash arsenal on the sidelines and the impact that flows to passive funds will have on this cohort of companies.”
It also ignores the fact that most of the business models across the largest companies, including the Magnificent Seven, are strong and powered by durable secular growth tailwinds that Orton believes should hold up regardless of economic environment going forward. He continues to have conviction in what he calls the “AI 2.0” basket of companies, which are the beneficiaries of rapid capital expenditures from the hyperscale cloud computing companies. And he noted that some of these companies trade at valuations lower than the broader index. Investors should consider leaning into the highest-quality growth businesses, he said, and that includes many of the mega-caps.
Yields might be down, but fixed income is still attractive: With U.S. inflation gauges such as the headline Consumer Price Index and the core Personal Consumption Expenditures (PCE) Price Index back below 3% year over year, Orton said U.S. Treasuries seem to have regained their role as a decent hedge against significant equity drawdowns. Elevated inflation levels produced positive equity-bond correlations for much of this time, but that relationship seems to have reversed.
“There are still many investors who are overweight short-term cash instruments, and there are many reasons I’ve pointed out in the past about why cash almost always underperforms during rate-cutting cycles,” Orton said. “There are still opportunities to generate income, and any short-term reversal because of negative September seasonality, spending concerns around elections, or rate-cut repricing will provide investors with an opportunity to put more cash to work.”
While money market rates certainly aren’t going back to the 0% that most investors got accustomed to over the last 14 years, Orton expects them to settle around wherever the neutral rate is, perhaps between 2.5% and 3.0%. And he believes there are plenty of opportunities to do meaningfully better than that right now.
Opportunities in emerging markets and Europe, Australasia and the Far East. As yields and the U.S. dollar move lower, Orton sees meaningful implications globally. If the MSCI Emerging Markets Currency Index could break out, he thinks this would bode well for emerging market equities. There might be some volatility in the short term as the dollar reacted to the depth and pace of the market’s rate-cut pricing, but longer-term the path for the dollar looks lower. Orton favors emerging markets excluding China with India remaining his preference, particularly as it has lagged a bit on the recent global recovery. There are also opportunities in international developed markets, but he said selectivity is critical. He expects the European Central Bank to cut rates again in September as recent data bolstered the case that inflation continues to move lower, though the pace forward is still likely to be gradual. In Japan, he said the pace of rate hikes also is likely to be gradual given that market volatility and the underlying fundamental trends supporting the strength of Japanese equities remain largely in place. Orton had advocated for thinking about using recent downside opportunistically in Japan and said he continues to see value despite some heightened uncertainty around the impact on earnings from appreciation in the Japanese Yen Currency Index.
Can small caps sustain a breakout?
Russell 2000 Index since 2020
Source: Bloomberg, as of 8/30/24.
Friday’s employment data takes center stage. With a hefty four quarter-point rate cuts currently priced in by the end of this year, there’s a heightened risk for some market volatility should we see any sharp repricing. Orton expects the labor and activity data this week to show continued resilience, which would lean against the need for a 50-basis point cut from the Fed in September. In addition to jobs, Fed officials will get a lot more information this week via the July JOLTS report on Wednesday, ADP’s employment report on Thursday, and the Institute for Supply Management’s surveys on manufacturing and services on Tuesday and Thursday, respectively.
1 Unless otherwise indicated, all data cited is sourced from Bloomberg as of August 30, 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.
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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.
A breakout takes place when an index level or asset price rises above a resistance level (a price point that the metric in question has had trouble exceeding in the time period being considered) or a drops below a support level (the price at which buyers tend to enter the market).
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. Headline readings of CPI inflation, also known as nominal CPI inflation, include food and energy prices, which tend to be more volatile than other components of the Consumer Price Index.
Core inflation is measured by the Personal Consumption Expenditures (PCE) excluding Food and Energy, Price Index, also known as the core PCE 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, indices, or other variables move in relation to each other.
The discount rate is the interest rate set by the U.S. Federal Reserve for loans that the Fed makes to commercial banks or other depository institutions. It is distinct from the federal funds rate, which is a suggested rate for those private institutions when lending to each other.
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.
An earnings inflection marks a sudden change in the direction and rate of change of earnings growth. Earnings inflections can lead to either positive or negative change.
The federal funds rate, known as the fed 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.
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 “hard landing” occurs when a central bank’s unsuccessful management of interest rates causes a recession.
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 produces several surveys assessing business conditions and outlooks across a variety of industries. They include the ISM Purchasing Managers’ Index (PMI), which measures the prevailing direction of economic trends in the manufacturing sector, and the Services ISM® Report on Business®, which is based on data compiled from purchasing and supply executives and reflects 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.
Loose financial conditions are those in which it is relatively easier for businesses and other borrowers to get loans or credit on favorable terms.
The Magnificent Seven refers to the seven largest stocks by market capitalization in the S&P 500 Index, as of Dec. 29, 2023. Collectively they made up more than 25% of the market capitalization of the entire index. They are Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla.
Market capitalization, or market cap, refers to the total dollar market value of a company’s outstanding shares of stock.
Mega-cap stocks are the largest publicly traded companies as measured by market capitalization. Generally, this refers to companies with market capitalizations over $200 billion.
The neutral rate is the theoretical federal funds rate at which the stance of U.S. Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability.
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.
Retrenching is a term used to describe a pulling back of or reduction in some form of economic activity.
Rotation describes the movement of investments in securities from one industry, sector, factor, or asset class to another as market participants react to or try to anticipate the next stage of the economic cycle.
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.
Secular trends are large-scale and ongoing changes in economies and societies that have the potential to drive broad and lasting economic, technological, social or other kinds of changes.
Tailwind is a term used to describe events or market forces that exert a positive influence on an investment’s performance.
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.
A zero-sum game is a set of circumstances where a gain for any one party results in a loss for another.
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 Japanese Yen Currency Index tracks trends affecting the Japanese yen and its relation to other foreign exchange currencies.
The MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the United States and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to US citizens but not applicable to citizens in the overseas country.
The MSCI Emerging Markets Currency Index measures the total return of 25 emerging market currencies relative to the U.S. dollar, the euro, or the Japanese yen with the weight of each emerging markets currency being equal to its country weight within I the MSCI Emerging Markets Index.
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-601409 Exp. 1/3/2025
