Two big things you need to know: First, we see 2Q24 reporting season as a key test for the rotation trade that attempted to start up again last week. Second, we remain worried about a pullback in the S&P 500 given the latest developments on our sentiment and positioning work, but timing seems a bit more complicated due to last week’s CPI print and surge in optimism on Fed cuts.

If you’d like to hear more, here’s another five minutes.

Takeway #1: We see 2Q24 reporting season as a key test for the rotation trade that attempted to start up again last week.

• Generally, speaking, on reporting season we aren’t overly worried about consensus estimates being too high setting investors up for disappointment.

o Normally, sell-side estimates on a full-year basis are where they end up in reality by the time we get to mid year.

o We are a little worried revenues might be light, given last week’s soft CPI print and the high, positive correlation we’ve seen over time between inflation and S&P 500 revenues.

o But we take some comfort in the fact that even though companies have been beating less frequently on revenues in recent quarters, their earnings beat rates have been much strong. This has been a testament of the ability to the c-suite to manage through all kinds of challenges.

• What we’re more focused on right now regarding earnings is how it is presents a key test for the rotation trade.

o As we’ve discussed before, the stage has set for a rotation from Growth to Value and Large to Small in terms of valuation and positioning for quite some time.

 On positioning, for example, CFTC data has been showing Nasdaq 100 futures positioning back near all time highs in recent updates.

 Clearly mega cap growth has been over owned, and small cap has been underowned.

 Fed rates cuts, which historically benefit Small Caps relative to Large Cap, were the trigger that helped spark the Small Cap reversion trade.

o But for the rotation that’s been underway the past few days to be sustainable, we think the earnings backdrop needs to cooperate.

o Here, our work on upward revisions trends, a key gauge of earnings sentiment, is helpful.

 On the Mega Cap Growth side, the Top 10 names in the S&P 500 by market cap are still far outpacing rest of market on rate of upward revisions, however, this indicator may be peaking and the gap may be starting to shrink. If it keeps moving lower, that will be a good argument in favor of rotation to Value or a continuation of the broadening out.

 Separately, consensus revenue and net income growth forecasts are also baking in a big recovery for the Russell 2000 and have the index nearly catching up to the S&P 500.

o Overall, what we’re seeing right now is a strengthening case for rotating into Small Cap. We don’t have quite as much evidence that a rotation within Large Cap from Growth to Value will keep going, but we’re keeping an eye on the data to see if it emerges.

Moving on to takeaway #2: we remain worried about a pullback in the S&P 500 given the latest developments on our sentiment work, but timing seems a bit more complicated due to last week’s CPI print and surge in optimism on Fed cuts.

• We’ve been worried about a pullback in part due to seasonal patterns in recent years. Weakness has tended to emerge in August, September and/or October.

• Specifically, one of our sentiment models also continues to flirt with danger. Net bullishness on the weekly AAII survey came in at 27.5% last week in favor of the bulls, taking the four-week average up to 20.3%.

o This is the third time the weekly data point for net bulls has crossed 20% since late May. The four-week average hasn’t quite crossed the one standard deviation mark (above the long average) which is around 22%.

o In this context, we continue to be worried that the risks of a short-term pullback in the US equity market have grown and continue to grow.

o The S&P 500 is typically flat on a 3-month forward basis after hitting the 1 standard deviation mark.

• Increased confidence around Fed cuts complicates our thoughts on the timing of a pullback, however, especially if September ends up being the first cut. In recent cycles, the S&P 500 has tended to rally into the first cut, then pullback a bit in after it occurs.

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