Today in the podcast, we’ve got a lot to get through. Seven big things you need to know: First, geopolitical concerns are spiking at a time when stocks already seemed due for a pullback. Second, the rotation trade has just gotten a lot more complicated. Third, companies have been keeping expectations low on earnings. Fourth, our valuation modeling suggests some modest downside risk to the stock market if we don’t get cuts, and a more significant hit if we get more hikes. Fifth, Small Caps may be stuck in a holding pattern for a while. Sixth, Biden has closed the gap with Trump in betting markets. Seventh, US equity flows have fizzled.

If you’d like to hear more, here’s another 7 minutes. Let’s jump into the details.

#1: Geopolitical concerns are spiking at a time when stocks already seemed due for a pullback.

One point that kept coming up in our meetings last week was that equity markets have a tough time pricing in geopolitical risks too far in advance. Recently, equity investors appear to have been baking in rising geopolitical risks by buying the Energy sector, which has easily been the top performing sector in Large Cap and Small Cap in recent months. That seemed to change at the end of last week as the S&P 500 broke below its early-April low on Friday’s close. We reminded investors last week that sentiment has been looking frothy on a number of indicators including the weekly AAII survey and CFTC’s weekly positioning data in US equity futures. How bad could a pullback get? For now, our assumption is that it would be in the 5-10% range. The drawdown in the S&P 500 that occurred last summer and fall ended up being around 10%, and typically any drawdown beyond 10% involves a serious scare about economic growth. This assumption could change, however, depending upon how geopolitical risks play out and if the economic narrative takes a turn for the worse.

#2: The rotation trade has just gotten a lot more complicated.

One of the best questions we got last week was what the hot inflation data means for the leadership rotation in the US equity market that seemed like it was finally getting underway. Our answer: generally we think higher inflation and fears over higher interest rates are good for the mega cap growth stocks. Since SVB, the Large Cap Growth/Value trade and the performance of the top 10 names in the S&P 500 relative to the rest of the market have been moving more or less in sync with trends in 10-year yields. We think this is in part due to better balance sheets in the biggest cap growth stocks.

#3: Companies have been keeping expectations low on earnings. Earnings didn’t come up too much in our meetings last week, but it’s still worth taking a moment to highlight our thoughts as 1Q24 reporting season gets underway. The setup for earnings is interesting to us for a few reasons. For one thing, the decline in bottom-up EPS forecasts for the S&P 500 has been milder than what we typically see (cuts to bottom-up forecasts are the rule not the exception).

#6: Biden has closed the gap with Trump in betting markets. We’ve talked a lot about the shifting dynamics in the race for the White House over the last few weeks so won’t spend too much time here. But it’s worth noting, given how in focus the US Election has been for non-US investors, that Biden is now tied with Trump in betting markets. As we noted last week, this challenges a key assumption of non-US investors that Republicans will sweep this fall. Ultimately, we think it’s important to remind investors that stocks tend to go up regardless of which party controls the White House and Congress.

And finally, #7: US equity flows have fizzled. Something else that’s worth a quick mention – US equity funds are suddenly seeing outflows. Outside of the US, most major geographies remain weak, though Canada flows have started to improve a bit. Within the US, flows for Large Caps and Small Caps are both under pressure as are all of the major styles. Passive deterioration is noteworthy, while active is holding up much better. At the sector level, growth and defensive sectors are generally seeing the worst trends while cyclical and commodity sectors are seeing improving and/or positive flows.

That’s all for now, thanks for listening. And be sure to reach out to your RBC representative with any questions.