This week in the podcast, we discuss the latest developments in investor and earnings sentiment, which we’ve been keeping a close eye on this month, as well as a few thoughts on the rotation out of growth we’ve been seeing this week. Three big things you need to know.
1. First, institutional investor positioning has finally taken a hit.
2. Second, earnings sentiment has continued to deteriorate, driven by cyclicals and supply chain concerns, but so far the damage has been concentrated in a few sectors.
3. Third, we think there’s more to the rotation out of Growth this week than higher bond yields, but regardless this rotation has become another catalyst for downside in the US equity market in the near-term.
Our bottom line, as we think across all of these issues, is that the volatility we’ve been in as regards to the broader US equity market likely isn’t done yet.
If you’d like more details, 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 podcast platforms.
Now, the details.
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Takeaway #1 – Institutional investor positioning has finally taken a hit.
• Last week in the podcast, we highlighted how individual investor sentiment, as captured in the weekly poll by the American Association of individual investors, had fallen so hard it was sending a preliminary, contrarian buy signal.
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• This week, the really important thing we’re seeing on the sentiment data is that institutional investor sentiment finally took a significant hit, with the latest data from CFTC on asset manager positioning in US equities (all contracts combined) falling for the 2nd week in a row and making a significant move lower.
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• A decline in positioning in S&P 500 contracts contributed to the move, meaning investors pared back on general US equity market exposure not just specific trades within it.
• Even with last week’s dip, institutional investor positioning does remain quite elevated relative to history, suggesting the stock market remains vulnerable to bad news on fundamentals.
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Takeaway #2 – Earnings sentiment has continued to deteriorate, driven by cyclicals and supply chain concerns, but so far the damage has been concentrated in a few sectors.
• Whether that will continue to be the case is a critical question for the stock market in the weeks ahead.
• This past week, the deterioration in the rate of upward EPS estimate revisions for the S&P 500 became even more pronounced, falling to 59% vs. a peak of 78% in August.
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• Secular Growth oriented sectors remained resilient, at the high end of their range. Technology was the strongest sector by far and stayed at the high end of its range.
irst time since the summer of:
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• Within Cyclicals, two sectors were responsible for the damage – Industrials and Materials. These are the only two sectors that have fallen into negative revision territory.
• Elsewhere within Value, Financials has been resilient, supported by higher bond yields. Energy has been one of the strongest sectors across the board.
• This reinforces our call from the summer that it’s time to be more selective with Cyclicals going forward – we’re sticking with our Financials and Energy overweights. As you may recall, we lowered Materials to market weight in August from overweight in part because of the deterioration we’d started to see on revisions trends.
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Wrapping up with Takeaway #3 – We think there’s more to the rotation out of Growth this week than higher bond yields, but regardless this rotation has become another catalyst for downside in the US equity market in the near-term.
• The big news so far this week has been how bond yields spiked in the aftermath of last week’s more hawkish than expected FOMC meeting. That move up in bond yields have sparked rotation out of Growth and outperformance by Value and Small Cap.
• But what many people aren’t noticing is that the higher frequency economic indicators that we track on dining, flying, public transit, consumer comfort, and return to work have mostly looked stable in recent updates.
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• Negative economic surprises in the US are also showing preliminary signs of bottoming.
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• And the noise that we’d seen post Labor Day seemed to suddenly disappear from the stats on domestic COVID cases, with our latest updates suggesting the worst of the Delta surge may be behind us.
• These are all good data points for the Value and Small Cap trades, which tend to be more of an expressions of Cyclicality in the stock market.
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• When we think about what this rotation – and the potential for it to continue in the near term – means for the stock market, the key thing to remember is this. Secular growth oriented sectors – CD, Comm, and Tech – tend to underperform 10 year yields rise.
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• And collectively, they account for more than half of the S&P 500’s market capitalization. As long as bond yields are spiking – a question we won’t try to answer – and are triggering rotation out of those sectors, it’s just mathematically very challenging for the S&P 500 to move higher. Meaning that the rotation is just something else we can add to our list of reasons why broader stock market volatility may endure a little while longer.
That’s all for now, thanks for listening, and please reach out to your RBC representative with any questions.
