Artwork for podcast RBC's Markets in Motion
Trading Like Fed Is Done, Case For Valuation Expansion, EPS Sentiment Improves
Episode 57th February 2023 • RBC's Markets in Motion • RBC Capital Markets
00:00:00 00:06:40

Share Episode



I’m Lori Calvasina, head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

Today in the podcast, hot topics and interesting things that jumped out in our inbound client questions and high frequency indicators from last week.

Four big things you need to know:

First, recent sector leadership within the S&P 500 is consistent with what we’ve seen in the past after final Fed rate hikes.

Second, we continue to find that investors are interested in debating what kind of P/E multiple the S&P 500 deserves in light of current interest rate and inflation assumptions. With this in mind, we’ve refreshed our valuation model which makes the case for valuation expansion as inflation moderates.

Third, earnings revisions trends are getting less negative for most S&P 500 sectors, suggesting that sentiment around earnings is improving at the margin, helping explain why the stock market has surged despite estimates continuing to fall in dollar terms.

and Russell:

If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify, and other major platforms. Now, the details.

Let’s start with takeaway #1: First, recent sector leadership within the S&P 500 is consistent with what we’ve seen in the past after final Fed rate hikes.

For us the most interesting part of Fed day is always how different sectors react in terms of performance. The top two sectors following Tuesday’s close were Communication Services and Tech, while Consumer Discretionary also eked out some outperformance.

While much of those moves can be explained by reactions to earnings prints, other drivers are also at play as these three sectors are also showing the strongest leadership within the S&P 500 YTD.

ng final Fed rate hikes since:

The top three performing sectors are Tech, Communication Services, and Consumer Discretionary. Financials also fared well, but not as strongly as the other three.

This tells us that the US equity market has been starting to discount the end of the current hiking cycle before it actually happens.

Tech and Comm Svcs were the two worst performers on Monday in the S&P 500 – a consequence of digesting Friday’s strong jobs report which has stoked concerns about the Fed’s hiking path once again.

Personally I’m still in the camp that thinks the Fed is close to the end of hikes.·

But in the short term these are the sectors to keep an eye on as we continue to digest more Fedspeak in the weeks ahead.

Moving on to takeaway #2: The Case For Valuation Expansion As Inflation Moderates

In our meetings last week we continued to find that investors were interested in debating what kind of P/E multiple the S&P 500 deserves to trade at in light of current interest rate and inflation assumptions.

sed on data going back to the:

Based on actuals, the model implies that the S&P 500 deserved to trade at 16.37x as of December 31st, 2022 (a little below the ~17.3-17.7x multiple it actually traded at using bottom up consensus and RBC 2022 EPS forecasts, respectively).

rent macro assumptions for YE:

This forecast multiple implies that at YE 2023 the S&P 500 could move up to nearly 5,000 (if the current consensus EPS forecast of $223 proves correct) or to nearly 4,500 (if RBC’s forecast of $199 proves correct).

Given our below outlook for:

Next, takeaway #3: Earnings Revisions Trends Are Getting Less Bad For Most S&P 500 Sectors

th the pace of beats slowing,:

We pointed out in last week’s podcast that we think the stock market has been rallying recently in part because the consensus stats are still baking in recovery on EPS, revenues, and margins in 2024 while valuations also look reasonable on 2024 consensus forecasts for EPS.

This week, we highlight another reason why we think US equities generally and the Growth trade in particular have rallied so hard YTD. While downward revisions to EPS forecasts are still underway, the rate of upward EPS estimate revisions has been starting to get less negative for six out of eleven S&P 500 sectors. We view this indicator as a good gauge of sentiment around earnings, which is starting to recover for the Growth oriented sectors in particular.

Wrapping up with a couple of quick hits from our high frequency indicators.

Correlations are coming down within the S&P 500, good news for stock pickers. Correlations are currently lowest within Health Care, Consumer Discretionary, and Comm Services.

performance was seen in late:

That’s all for now. Thanks for listening. And be sure to reach out with any questions.