Today in the podcast, we update our thoughts on the broader US equity market outlook as well as bigger picture positioning trades. Three big things you need to know: First, there’s no change to our year-end 2022 S&P 500 target of 4,200 or our 2023 S&P 500 EPS forecast of $212, though we have tweaked our 2022 S&P 500 EPS forecast up to $218 from $214. Second, we continue to anticipate choppy conditions through year end, in which stocks are caught in a tug of war between deeply bearish sentiment and ongoing concerns about further Fed tightening and its longer-term economic ramifications and downward earnings revisions. The mid-term elections remain a major headache, but may ultimately still be a positive catalyst. Third, we continue to prefer US equities over non-US equities and Small Cap over Large Cap. We wouldn’t be surprised to see the pause in Growth leadership persist in the near term, but still like Growth over Value longer term given that we expect a sluggish economic backdrop to be the price markets will have to pay for a short/shallow economic downturn.
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There’s no change to our YE:
• Our 4,200 forecast is roughly the average of 9 different scenarios and back tests that we examined. We come up with a wide range of outcomes which underscores the complexity of the backdrop this year.
o Our most optimistic test –which assumes the S&P 500 bottomed in mid June and sees its typical 6 month post recession bottom rally – puts the index just below 5,000 at year end.
% for the full year in:
o Our cross asset indicators, which look at stocks vs. bonds, suggest the index deserves to end the year around 4,100.
% range by the end of:
Takeaway #2: We continue to anticipate choppy conditions in US equities through year-end, essentially a tug of war between the bearish and bullish narratives in play.
• Major problems include further downward revisions to earnings, the mid-term elections (where Democrats are gaining on Republicans in polling and betting markets)…
o valuations (which are looking a bit elevated again), Fed tightening (which tends to pressure P/E’S and hit economic growth), declines in C suite confidence, and likely deterioration in the economic/labor backdrop.
• But we are also mindful that the S&P 500 tends to bottom in major crises while earnings forecasts are still falling, think it’s still more likely than not that the Republicans will take at least one chamber of Congress in November, note that valuations are still well below past peaks and that substantial contraction already took place at the mid June lows, see evidence that corporate balance sheet strength is providing a cushion to EPS, and have done some work suggesting that the stock market is already baking in a material deterioration in the labor market.
• Supply chains also improving, inflation expectations have peaked, and high frequency economic indicators are stable or improving, and employment indicators have calmed down, keeping the deeply bearish narratives in check.
Financial Crisis, on par with:
Takeaway #3: In terms of positioning, we continue to prefer US equities over non-US equities, think the pause in growth leadership may persist a little while longer but still like growth longer-term, and continue to see Small Caps over Large Caps are our highest conviction call.
• On the US/non-US call, even though we think US equities are likely to keep benefiting from safe haven treatment for a while longer, though we have grown concerned about valuations as US equity valuations are starting to get back to peak relative to non US equities again. This trade bears watching closely.
• On growth/value, we’ve been talking about how the Growth trade was starting to look crowded again at the end of the summer, based on CFTC data on Nasdaq futures positioning for asset managers. The unwind has started but hasn’t fully played out and this could keep some pressure on Growth short term.
o But longer term, we continue to prefer Growth due to its higher quality and the tendency of Growth to outperform Value when real GDP growth is tracking below 2%, the likely price to pay for a short/shallow recession.
• Small Cap over Large Cap remains our highest conviction call.
o Small Caps typically start to outperform Large Cap midway through recessions and when the unemployment rate starts to move up.
o We also believe that a recession was baked into Small Cap performance well in advance, as is typically the case.
• Positioning in Small Caps by asset managers in the futures market has been well below financial crisis lows.
• R:
• And Russell 2000 performance relative to the S&P 500 over the past year resembles what one would expect to see if we’d already seen ISM manufacturing drop to typical troughs.
• The forward P/E of the R:
o We have gotten some questions about why Small Caps ended the summer on a weaker note. We think this is because EPS revisions trends stopped favoring Small Cap over Large Cap as they did in the spring.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for thoughts on specific sectors from RBC’s team of industry analysts.
