Markets in Focus

Timely analysis of market moves and sectors of opportunity

March 28, 2022: That flattening yield curve: Question your assumptions

Equities continued to move higher last week with the S&P 500 Index holding above the 4400 level even as the bond rout deepened. In addition to energy and materials outperforming, Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, said it was encouraging to see information technology, including mega-cap tech, continue to bounce back from deeply oversold conditions even with the backdrop of bond yields pushing higher. Orton said he has received many questions about this dynamic, with most investors very skeptical of the move higher. He takes a different view.

“I actually think it makes sense and it fits with the theme of ‘peak hawkishness’ that we’ve been discussing for the past few weeks,” he said. “Sentiment and positioning just got too bearish, and equities were pricing in worst-case scenarios. Earnings estimates and margin expectations have also been holding up well pretty well, giving me additional comfort with a more optimistic view of U.S. equities.”

But what about the geopolitical risks and how do they impact the outlook going forward? One of the reasons Orton said he hears for continued skepticism has been that both U.S. and European equities have been quite resilient — perhaps too resilient — in the face of the Russia-Ukraine war. Issues ranging from supply chain disruptions to increased energy and food prices are all likely to increase inflationary pressures and recession risks, all of which should be headwinds to equities, he said. But instead, the table below shows that the S&P 500 is up over 7.5% since the Russian invasion on Feb. 24 and the Euro STOXX 50® Index is nearly flat (though European banks are still off almost 15%). Economically-important commodities directly impacted by the war and sanctions have had a substantial rally, which Orton said has in turn helped spur a rise in bond yields.

Change since invasion (Feb. 24)
S&P 500 Index 7.52%
10-year U.S. Treasury Yield 0.48%
Euro STOXX 50 Index -2.66%
Euro STOXX® Banks Index -14.92%
MSCI EAFE® (Net) Index -1.86%
MSCI Emerging Markets Index -6.78%
10-year German Bund yield 0.36%
June Brent crude oil 27.33%
May wheat 24.58%

Source: Bloomberg, as of 3/25/22.

It’s understandable for some to think that the move in equities is overdone, Orton said, but remember that the S&P 500 is still off nearly 5% year to date. He also noted that when looking at past market experiences with geopolitical issues, the initial response tends to be an over-reaction which reverses relatively quickly. Business sentiment hasn’t suddenly flipped negative and calendar year 2022 margin expectations have held pretty steady, he said. The estimated first quarter net profit margin for the S&P 500 stands at 12.2%, just below the 12.4% from last quarter and well above the 5-year average of 11.0%. Earnings growth for 2022 is expected to be a solid 9.4%, he said, hardly a reason for alarm.

Despite this optimism, Orton said he does not advocate for chasing the upside. Rather, he said investors should continue to use downside opportunistically. This has worked quite well in areas like higher quality technology and healthcare that he has liked. In particular, semiconductors have strong long-term secular growth tailwinds and have experienced massive valuation compression year to date. Cybersecurity is a theme he has discussed for months and geopolitical tensions have certainly placed a spotlight on many of these companies. He said these growthier companies are also worth considering if you’re concerned about slowing economic growth. Dividends — notably dividend growth — is another place to consider in a higher inflation environment, he said. Dividends are the second best performing factor year to date and he said he expects dividend growers to continue to outperform. Finally, he said he still believes it’s too early for small caps and advocates for staying in large or mid caps. The Russell 2000® Index underperformed relative to the broader market last week and Orton said he just doesn’t see any sort of breakout on the horizon. Orton said he was encouraged to see relative sector performance in small-cap healthcare, information technology, and financials all continue to improve. That, he said, makes him inclined to believe we can see small-caps break out, but he prefers to wait and see rather than be in too early.

Should we worry about the “2s10s” spread?

The flattening of the yield curve has put many investors on edge. But Orton said the conventional wisdom that an inversion of the 10-year minus 2-year yield spread (known as the 2s10s) is a harbinger of recession just isn’t very helpful. Rather, he said, it’s important to consider why the curve inverted and contextualize past episodes. In 2019, for example, the curve inverted as a result of tariffs and global trade policy. The recession that followed in 2020 was a consequence of the COVID-19 pandemic, not anything to do with the yield curve inverting. Additionally, Orton said when we analyze historical equity performance post-inversion, it certainly doesn’t look like a good sell signal. When looking at all 2s10s inversions since 1977, the median S&P 500 gain one year after the inversions was 12.3% (with positive performance in the 1-month and 3-month time periods post-inversion as well).

S&P 500 performance after
Date of 2s10s Inversion 1 month 3 month 1 year
8/26/2019 3.9% 8.5% 16.7%
4/13/2007 3.6% 5.3% -9.5%
1/31/2006 0.0% 1.7% 11.9%
12/27/2005 0.6% 3.2% 12.3%
2/2/2000 -2.1% 3.7% -5.7%
5/26/1998 2.3% 0.7% 23.9%
3/8/1990 0.1% 6.2% 7.3%
1/5/1989 6.0% 4.5% 23.1%
12/14/1988 2.4% 6.8% 24.8%
1/18/1982 -2.4% -1.0% 18.0%
10/27/1981 3.5% -2.8% 12.7%
9/11/1980 4.3% 8.6% 24.8%
8/17/1978 0.0% -10.1% -0.9%
 
Median 2.3% 3.7% 12.3%
Maximum 6.0% 8.6% 24.8%
Minimum -2.4% -10.1% -9.5%
Positive Ratio 84.6% 76.9% 69.2%

Source: Bloomberg, as of 3/25/22.

Investors also should consider whether the 2s10s is the best spread to follow to get a useful signal around recession, Orton said. There are many other spreads that get attention, such as the 10-year minus 3-month spread, the 5-year minus 3-month spread, or the 5-year minus 2-year spread.

“There are a lot of different curves that you can use to gauge what might be an appropriate metric for recession risk,” he said, “and really, when you look at almost any other appropriate curve besides the 2s10s, you get a very different story. A lot of these curves are steepening.”

Orton said he thinks a more useful spread is actually the 18-month forward rate for the 3-month Treasury bill versus the current 3-month rate (the 18m3m — 3m spread). That’s because rates further out are distorted by a multitude of supply-demand dynamics, and Orton said he also would argue that the 2s10s doesn’t capture the U.S. Federal Reserve’s view of the economy. Fed visibility at best probably goes out two years, he said, so looking at the 18-months forward 3-month rate — the topic of a widely discussed Fed whitepaper — captures this. Orton said he believes it provides a more useful insight into the Fed’s assessment around recession, which ultimately will guide rates. And he said when we look at the 18m3m — 3m spread, it tells a completely different picture than the 2s10s flattening.

“That curve has been meaningfully steepening over the past couple of weeks,” Orton said. “So over a breadth of different metrics, we’re not really seeing that recession harbinger suggested by the 2s10s playing out. That doesn’t mean there aren’t reasons for concern, just that they’re likely overstated right now.”

Different yield spreads tell very different stories about the economy

Different yield spreads tell very different stories about the economy

Source: Bloomberg, as of 3/25/22.

Given the track record of the S&P 500 following the inversion of the 2s10s going back to 1977, Orton said that using the inversion of the 2s10s “as a reason to be cautious on equities just doesn’t hold water.”

“You’ve got to look at what else is going on,” he said, “and when I see what’s going on, there are certainly risks to the consumer and risks to the economy, but I am more sanguine about both of those given the data that we currently have and what I actually see people doing. Beyond that, you’ve got to look at corporate earnings. We haven’t seen meaningful margin compression. Estimated margins heading in for first-quarter earnings have only come down about 20 basis points from last quarter. So you’re not seeing compression on corporate profitability, even given this breadth of news about inflationary concerns, supply chain issues, or the war in Ukraine. That, to me, is a pretty positive indicator about where we are.”

What to watch

There are number of important economic data releases this week, including consumer confidence and U.S. non-farm payrolls on Friday, plus earnings reports from companies in financial services; restaurants and entertainment; computer equipment; sportswear; pet products; furniture and home goods; discount retail; payroll and benefits services; and pharmacies.

This week's data releases

Monday U.S. wholesale inventories
Tuesday U.S. Consumer Confidence Survey®; Japan unemployment
Wednesday U.S. gross domestic product; European Union report on Economic Sentiment and Employment Expectations; Germany and Spain inflation; Japan retail sales
Thusday U.S. initial jobless claims; U.K. gross domestic product; China Purchasing Manager Index; Euro-area unemployment
Friday U.S. Non-farm payrolls, unemployment, Institute for Supply Management (ISM) manufacturing Purchasing Managers’ Index; Eurozone Harmonised Index of Consumer Prices

 

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Carillon Tower Advisers or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer; or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Hawkish, dovish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Centrists tend to occupy the middle of the continuum between tight (hawkish) and loose (dovish) monetary policy.

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

A bund is a bond issued by Germany’s federal government. It is generally viewed as the German equivalent of a U.S. Treasury bond.

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. When yields for longer-term debt drop below yields for shorter-term debt that has the same risk profile, the curve is said to be inverted or to have gone negative.

A credit spread, as discussed here, is the difference in yield between U.S. Treasury instruments with different maturities. Spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points.

Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.

The U.S. 2/10 Curve, known as the 2s/10s, is a bellwether indicator that measures the difference between the rates of the 10-year U.S. Treasury bond and the 2-year Treasury note. Measured in basis points, it is watched as an indicator of where the U.S. economy is in the business cycle, as the spread typically narrows as the economy moves through the cycle, reaches a low point and may go negative near the onset of a recession, then widens again during and after a recession.

The forward rate is an interest rate for a financial transaction that will take place in the future. Forward rates are calculated from spot rates. The relationship between spot and forward rates is similar to the relationship between discounted present value and future value.

The U.S. Consumer Confidence Survey®, published monthly by The Conference Board, reflects prevailing business conditions and likely developments for coming months based on consumer attitudes, buying intentions, vacation plans, and expectations for inflation, stock prices, and interest rates.

The China Purchasing Manager Index, compiled by the National Bureau of Statistics of China, is based on a monthly survey of purchasing managers in 31 divisions of manufacturing enterprise and 43 divisions of non-manufacturing enterprise.

The Purchasing Managers’ Index (PMI) measures the prevailing direction of economic trends in the manufacturing sector. It is created by the Institute for Supply Management (ISM), and consists of an index summarizing whether market conditions as reported in a monthly survey of supply chain managers are expanding, staying the same, or contracting.

The Eurozone Harmonised Index of Consumer Prices is a composite measure of inflation in the Eurozone based on changes in prices paid by consumers in the European Union for items in a basket of common goods. The index tracks the prices of goods such as coffee, tobacco, meat, fruit, household appliances, cars, pharmaceuticals, electricity, clothing, and many other widely used products.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 10% of the total market capitalization of the Russell 3000® Index.

The EURO STOXX 50® Index is a blue-chip index designed to represent 50 of the largest companies from eight Eurozone countries: Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands, and Spain.

The EURO STOXX® Banks Index tracks companies within the banking sector of the Euro STOXX® Index, which tracks large-, medium-, and small-capitalization companies in 11 Eurozone countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.

The MSCI EAFE® (Net) Index measures the performance of performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The MSCI EAFE® (Net) Index subtracts any foreign taxes applicable to US citizens but not applicable to citizens in the overseas country. DM countries include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the U.K. and the U.S. EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

The MSCI Emerging Markets® Index measures the performance of large and mid-cap stocks across 24 emerging markets (EM) countries. EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication.

 

CTA22-0214 Exp. 7/28/2022


March 21, 2022: Seeing a market bottom

Equity markets got some much-needed relief last week from the extreme pessimism that has dominated the narrative recently, said Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers. It was encouraging to see dip-buyers return to the market and even more encouraging to see the S&P 500 Index break through resistance and hold above 4400.

“The S&P 500 is up just about 6% over the course of a week, which is significant,” Orton said. “We definitely needed to see such meaningful improvement for the overall market, and a lot of technical signals have flipped to decidedly more positive. I think it’s still going to be a bumpy ride with more downside likely, but overall, given the changes that we saw last week, I feel more confident in saying that we’re in the process of putting in a bottom for the market.”

There is, however, still plenty of negativity and Orton said he can appreciate how, at first glance, the moves following the Federal Open Market Committee (FOMC) rate decision might appear to make very little sense. The message from the U.S. Federal Reserve (Fed) was loud and clear, and decidedly hawkish. Chairman Jerome Powell highlighted price stability as the No. 1 priority and appeared to endorse the message from the “dot plot” that rates will likely have to exceed neutral for this to be achieved. But equities surged higher with nominal 10-year U.S. Treasury yields eventually falling to pre-FOMC levels, while real yields were quite a bit lower than they were before the Fed announcement. On reflection, Orton said these moves actually make a lot of sense. That’s because they fit within the context of “peak hawkishness” that Orton has been discussing for the past few weeks. He noted that the bar for hawkish surprises was relatively high following Powell’s semi-annual congressional testimony in early March. Powell’s assurance that the economy is very strong and able to withstand tightening also was encouraging and helped to assuage some concerns that we would tighten into a recession. Mix in extremes in bearish investor sentiment and institutional positioning and Orton said we had a cocktail for the market to bounce higher. The key question now is whether this can continue.

Price action over the next few days will be critical to answering that question. If we can hold the 4400 range on the S&P 500, Orton said he believes that bodes well for further upside. Additionally, he said it would give him additional conviction that the market can trade higher to see investors continue to wade back into higher quality names, especially in information technology, that were thrown out with the bathwater.

“But make no mistake,” Orton said. “Volatility isn’t going anywhere, and it’s not going to be smooth at all. One negative headline and we can see deterioration again.”

That’s why Orton said he continues to believe this is a time for active management and to lean from a factor standpoint into quality, dividend growth, and low volatility. Growth bounced last week due to incredibly oversold conditions and Orton said he still likes higher quality, positive-earning companies in software and semiconductors, where there are opportunities given massive valuation compression despite strong fundamentals. He said he also still likes healthcare, notably healthcare technology and providers and services. Orton acknowledged that he was a bit early on this, but noted that the overall sector has started to perform well and these specific industry groups have outperformed.

Growth vs. value: Watch higher quality growth

Growth has hit stretched pessimism territory versus value in the United States as the relative performance crashed through the May 2021 lows. We’re currently sitting at notable support, and Orton said he believes a failure to hold the lows reached early last week would point to a further breakdown in growth relative to value. That said, we’ve already seen massive multiple compression in growth stocks year to date, and Orton said the bounce in mega-cap technology last week post-FOMC is encouraging. Fundamentals in higher quality growth names are impressively strong, he said: Earnings growth has delivered, earnings-per-share projections have held up relatively well, and margins are more insulated from inflationary pressures. Semiconductors also were sitting at historically oversold levels, with only 6% trading above their 200-day daily moving average, and he said he’s looking for further gains absent any negative geopolitical headlines.

“There are some excellent long-term investment opportunities right now in the growthier parts of the market,” Orton said.

MSCI USA Growth to MSCI USA Value ratio bounced off
critical levels last week. Can it hold?

MSCI USA Growth to MSCI USA Value ratio bounced off
critical levels last week. Can it hold?

Source: Bloomberg, as of 3/18/22.

Small caps: Looking for strength in critical sectors

U.S. small caps have improved markedly over the past two weeks. Relative performance between the Russell 2000® Index and the S&P 500 has gradually been improving while breadth jumped higher last week after a period of positive divergences. Valuations are back to levels last seen in March 2020 with both top and bottom line projections for the Russell 2000 in 2022 and 2023 beating the S&P 500. So why is Orton still not convinced it’s time to jump back in?

Performance across some critical sectors still hasn’t improved on a relative basis, he said. Given the concentrations in sectors like IT, healthcare, and financials, he said we need to see some strength in at least one (if not all) of these sectors. Yet small-cap financials have deteriorated, while healthcare and IT remain weak. That said, Orton said he believes healthcare appears to be forming a bottom, and IT surged last week. If we can see follow-through, then he said he thinks it might be time to give the all-clear. In the meantime, he said, “I’ll give the benefit of the doubt to being conservative.”

Are small caps finally starting to turn?

Are small caps finally starting to turn?

Source: Bloomberg, as of 3/18/22.

What to watch

It will be a busy week from a macro perspective with some important data releases and Fedspeak, plus earnings from companies in athletic shoes and sportswear; software; cruise lines; online clothing sales; Chinese-based technology; food products; recreational vehicles; and restaurants.

This week's data releases

Monday Fed Chairman Jerome Powell speaks to the National Association for Business Economics; German Producer Price Index
Tuesday Remarks scheduled from Federal Reserve Bank of New York President John C. Williams (a centrist on monetary policy), Federal Reserve Bank of San Francisco President Mary C. Daly (who leans dovish), and Federal Reserve Bank of Cleveland President Loretta J. Mester (who leans hawkish)
Wednesday Remarks from Powell, Daly, and Federal Reserve Bank of St. Louis President James Bullard (hawkish); U.K. Consumer Prices Index
Thusday Remarks from Federal Reserve Bank of Minneapolis Neel Kashkari (mostly dovish), Fed Board of Governors member Christopher J. Waller (hawkish), Federal Reserve Bank of Chicago President Charles L. Evans (dovish), and Federal Reserve Bank of Atlanta President Raphael Bostic (hawkish); President Joe Biden attends NATO summit
Friday University of Michigan Index of Consumer Sentiment

 

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Carillon Tower Advisers or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer; or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Real yield curve rates, commonly referred to as “Real Constant Maturity Treasury” rates, on Treasury Inflation-Protected Securities (TIPS) at “constant maturity” are estimated by the U.S. Treasury from the Treasury’s daily par real yield curve. These par real yields are calculated from indicative secondary market quotations obtained by the Federal Reserve Bank of New York. The par real yield values are read from the par real yield curve at fixed maturities, currently 5, 7, 10, 20, and 30 years. This method provides a par real yield for a 10-year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity.

Technical indicators track historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

Hawkish, dovish, and centrist are terms used to describe the monetary policy preferences of central bankers and others. Hawks prioritize controlling inflation and may favor raising interest rates to reduce it or keep it in check. Doves tend to support maintaining lower interest rates, often in support of stimulating job growth and the economy more generally. Centrists tend to occupy the middle of the spectrum of tight (hawkish) to loose (dovish) monetary policy.

Oversold is a term used to describe a security believed to be trading at a level below its intrinsic or fair value.

Growth investing is a stock-buying strategy that focuses on companies expected to grow at an above-average rate compared to their industry or the market.

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.

The daily moving average (DMA) is a calculation that takes the arithmetic mean of a given set of prices over the specific number of days in the past; for example, over the previous 15, 30, 100, or 200 days.

Internals refer to quantitative market indicators that investment professionals monitor to spot trends and forecast movements within securities markets. A subset of technical indicators, internals include a number of formulas and ratios, such as the number of stocks moving in the same direction as a larger trend, the ratio of securities with rising and falling prices, the ratio of new highs to new lows, and price and volume indicators that are seen as indicators of overall market sentiment.

The German Producer Price Index is compiled by Germany’s Federal Statistical Office on a monthly basis to track the prices of industrial products that include energy, capital goods such as machines and vehicles, intermediate goods such as raw materials, wood, metals, chemicals, and electronic intermediate circuits, and non-durable consumer goods such as butter, sugar, pork, poultry, and crude vegetable oils.

The U.K. Consumer Prices Index is a measure of consumer price inflation in the United Kingdom based a wide range of household spending, including on food, alcoholic beverages and tobacco, clothing and shoes, housing and utilities, health, transportation, communication, recreation, education, restaurants and hotels, and miscellaneous goods and services.

The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The MSCI USA Growth Index captures large and mid-cap securities exhibiting overall growth style characteristics in the United States. The growth investment style characteristics for index construction are defined using five variables: long-term forward earnings-per-share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, and long-term historical EPS growth trend and long-term historical sales per share growth trend.

The MSCI USA Value Index captures large and mid-cap U.S. securities exhibiting overall value style characteristics. The value investment style characteristics for index construction are defined using three variables: the ratio of book value to price, the 12-month forward earnings to price ratio, and dividend yield.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 10% of the total market capitalization of the Russell 3000® Index.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication.

 

CTA22-0192 Exp. 7/21/2022


March 14, 2022: The bearish call is all too common

What confidence! What self-assurance! As he reads through new investment papers and analyst reports, Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, said he can’t help but wonder how so many people can have so much confidence in their projections right now:

  • Confidence around the impact of the Russia-Ukraine war on the path of inflationary pressures;
  • Confidence around how consumers will respond to rising gas prices;
  • Confidence around the impact of sanctions on the global banking system and what the end-game will look like.

“Just think,” Orton said. “In little more than two years many economists and strategists have become seasoned epidemiologists able to forecast the spread of COVID-19 as well as geopolitical cognoscenti with a nuanced view of the current war. This false sense of confidence has whipsawed investor sentiment as projections don’t pan out and are rapidly adjusted. I can’t help but wonder how anyone can have so much confidence in anything over the next few weeks.”

Rather, Orton said it’s more useful to have a nuanced market view. We also need to be flexible in this view, he said. And most importantly, we should build our views around a few key questions. When the Russia-Ukraine crisis started to unfold a few weeks ago, Orton laid out three questions that he said still help inform his base-case market view going forward. He has since added a fourth question, since we cannot forget about the U.S. Federal Reserve (Fed), which will be in focus this week:

  1. How quickly will the crisis be resolved?
  2. Is this a regional or global issue?
  3. Have technicals washed out enough so we can see a decisive move higher?
  4. What are the implications of the start of the Fed rate hike cycle?

The Russia-Ukraine crisis has already gone longer than many initially expected, and Orton said he suspects it will drag on for a while. Additionally, it’s much easier to institute sanctions than to unwind them, so even if we can quickly reach an acceptable détente, he said the economic implications will be much longer-lasting. That said, he believes a quick resolution would likely be met with a strong bounce in the market as investor sentiment recovers and a key element of uncertainty is removed. However, risks increase as the crisis drags on: Should it persist over the next few months Orton would expect the initial shock around energy to turn into challenges with respect to food security and key supply chain inputs. All of this would add additional uncertainty around the path of inflation and implications around global economic growth.

It’s important to emphasize that while the global economy feels the impact of the current crisis, the impact is not equal across different countries and regions, Orton said. For example, he said, the United States has a more independent economy — it has more of its own manufacturing capacity, is more energy-independent, and has growth mostly driven by domestic consumers — so the impact from sanctions and disruptions in flow of goods at this stage isn’t too meaningful outside of oil prices. In contrast, Europe’s economy depends more on inputs directly impacted by this crisis, notably energy, he said. Orton said he sees the desynchronized impact to the global economy as a good thing. If we can avoid a more synchronized slowdown, this should help buffer the global economy and allow for a faster recovery from those that are most impacted. Orton’s optimistic view of the U.S. consumer also plays into this theme and further supports his current preference for U.S. equities. It’s easy to get bearish on the consumer with rising gas prices and food inflation, but Orton said he believes those risks are overstated. U.S. Transportation Security Administration (TSA) checkpoint numbers are back to levels we saw over the holidays and are approaching pre-pandemic levels. Orton said he spoke over the weekend with the president of Visit Tampa Bay, a non-profit tourism development agency in the metro area where Carillon Tower Advisers is based, and learned that hotel occupancy rates over the next few weeks (spring break) are projected to be near capacity as well as that local tourism revenue last year broke 2019’s record and already is above trend for 2022. Orton noted he also still sees crowds at restaurants and long lines at the coffee shop drive-through. All of this gives him optimism that the consumer will get through this just fine, though, of course, we need to closely follow the data in the near term. We’ll get earnings from more consumer-related companies this week, which should provide us with additional insight into recent consumer trends.

U.S. TSA checkpoint total traveler throughput

U.S. TSA checkpoint total traveler throughput

Source: Bloomberg, Transportation Security Administration, as of 3/12/2022.

Despite the continued malaise in equities, we still haven’t hit the highly oversold levels that would give Orton confidence that we are at an absolute bottom. Investor sentiment remains atrocious, but market internals are not washed out. Further breakdown within the S&P 500 Index should help us get there, he said. Orton said he remains cautious about buying the market in the short-term, but he continues to suggest selectively adding exposure to oversold sectors, industries, and companies where fundamentals continue to improve. These include high-quality dividend-paying stocks, healthcare, regional banks, and quality tech companies that are leveraged to more secular growth plays and are insulated from some of the uncertainties in the economy, he said. We’re seeing good news being rewarded as companies host investor days or release strong earnings and guidance. We’re also seeing companies that were extremely oversold on headline news bounce back. Last week companies in online travel, cruise lines, resorts, airlines, restaurants, and heavy equipment manufacturing all had a great week.

While the technical picture is still somewhat mixed, Orton said he strongly believes that the bearish call is becoming too universal and sets us up for a big bounce once we can hit those oversold conditions. Stagflation now seems to a part of nearly every forecast, and he couldn’t disagree more.

“My overall message is that I believe the risks are being overstated,” Orton said. “I don’t see recession in the future. I think stagflation is a crazy word to be throwing around.” Last time he checked, the definition of stagflation was “persistent high inflation combined with high unemployment and stagnant demand in a country’s economy.” Orton noted that we have only one of these pre-requisites while unemployment sits near record lows, demand remains strong, and economic growth across nearly every Wall Street forecast sits between zero and 5%. Dynamics in the labor market also point to some strong positives for the consumer: There were 678,000 new jobs in February and the average work week rose by 2/10ths of an hour. That’s the equivalent of another 600,000 jobs in terms of total labor income. So, Orton said, we had an absolute surge in labor income in February, which creates a cushion against price shocks. Also, don’t forget about the massive surge in household net worth and the more than $2 trillion in accumulated savings. The bottom quintile of earners, which is the cohort most impacted by higher gasoline prices, have seen their wages increase 3% faster than the top quintile. None of this portends stagflation, he said, and the fact this has become a consensus call bodes well for the market as the bearishness unwinds.

Finally, with the Federal Reserve expected to meet this week and kick off a cycle of rate hikes, Orton noted that historically it has been the end of a Fed tightening cycle, rather than the start, that has been problematic for equities. And, he said, given the fact that we’re past “peak hawkishness” the equity market is already fully pricing in five rate hikes (down from a peak of seven just a few weeks ago). Using February 1994, June 1999, June 2004, and December 2016 as the starting points of four prior rate hike cycles, we have seen equity markets post positive returns one year following the first rate hike in all four instances. Equities had a modest correction of about 2% on average in the first one to three months, before rallying in the following six to 12 months. Looking longer-term, he said, you can see how any weakness has tended to be a long-term buying opportunity.

The start of rate hikes historically has led to short-term jitters
Average S&P 500 returns post rate hikes over the
past four rate hike cycles

The start of rate hikes historically has led to short-term jitters Average S&P 500 returns post rate hikes over the past four rate hike cycles

Source: Bloomberg, based on interest rate increases that began in February 1994, June 1999,
June 2004, and December 2016.

There also was massive valuation compression in advance of these rate hikes, Orton said. While he said he wouldn’t call equities cheap at the moment, they remain attractive relative to bonds, and there are many cheap opportunities on a single stock or sector/industry basis. Moreover, he noted that the 12-month forward price-to-earnings (P/E) ratios for both the S&P 500 and Nasdaq 100® Index are back to where we were in late 2019 relative to similar levels on the 10-year U.S. Treasury note.

A return to a pre-pandemic relationship
Forward price-to-earnings (P/E) and 10-year U.S. Treasury yield

A return to a pre-pandemic relationship
Forward price-to-earnings (P/E) and 10-year U.S. Treasury yield

Source: Bloomberg, as of 3/11/22.

 

A return to a pre-pandemic relationship
Forward price-to-earnings (P/E) and 10-year U.S. Treasury yield

Source: Bloomberg, as of 3/11/22.

 

What to watch

The Fed will be the focus this week, along with consumer-related earnings reports from companies in resorts; kitchen and home furnishings; discount retail; package shipping and delivery; and video games and consumer electronics.

Tuesday Empire State Manufacturing Survey, U.S. Producer Price Index; U.K. unemployment; Industrial output for the Eurozone and China
Wednesday U.S. Federal Reserve interest rate decision
Thusday U.S. initial jobless claims and industrial output; U.K. interest rate decision; Eurozone Harmonised Index of Consumer Prices
Friday Japan Consumer Price Index; Japan interest rate decision

 

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Carillon Tower Advisers or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer; or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Technicals refers to technical indicators of historic market data, including price and volume statistics, to which analysts apply a wide variety of mathematical formulas in their study of larger market patterns.

Oversold is a term used to describe a security believed to be trading at a level below its intrinsic or fair value.

Internals refer to quantitative market indicators that investment professionals monitor to spot trends and forecast movements within securities markets. A subset of technical indicators, internals include a number of formulas and ratios, such as the number of stocks moving in the same direction as a larger trend, the ratio of securities with rising and falling prices, the ratio of new highs to new lows, and price and volume indicators that are seen as indicators of overall market sentiment.

Cyclical stocks have prices influenced by macroeconomic changes in the economy and are known for following the economy as it cycles through expansion, peak, recession, and recovery.

Secular stocks are characterized by having consistent earnings over the long term constant regardless of other trends in the market. Secular companies often have a primary business related to consumer staples most households consistently use whether the larger economy is good or bad.

Price-to-earnings (P/E) ratios measure a company’s current share price relative to its earnings per share. The ratio is used to help assess a company’s value and is sometimes referred to as the price multiple or earnings multiple.

Forward earnings per share is an estimate for the next period’s earnings per share for a company’s profit divided by the outstanding shares of its common stock.

Forward price-to-earnings (forward P/E) is a version of the ratio of price to earnings that uses forecast earnings for the P/E calculation. The earnings used in this ratio are an estimate and therefore are not as reliable as current or historical earnings data.

The Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York.

The U.S. Producer Price Index (PPI), published monthly by the U.S. Bureau of Labor Statistics, measures the average change over time in the selling prices received by domestic producers for their output.

The Eurozone Harmonised Index of Consumer Prices is a composite measure of inflation in the Eurozone based on changes in prices paid by consumers in the European Union for items in a basket of common goods. The index tracks the prices of goods such as coffee, tobacco, meat, fruit, household appliances, cars, pharmaceuticals, electricity, clothing, and many other widely used products.

The Japan Consumer Price Index, released monthly by the Statistics Bureau of Japan, tracks inflation by monitoring price changes in a wide variety of goods and services, excluding fresh foods, purchased by households nationwide.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The Nasdaq 100® Index is a stock market index made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index.

 

CTA22-0181 Exp. 7/14/2022


March 7, 2022: The consumer is all right

Market whiplash on a daily — and even on an intraday — basis continued last week in spite of some earnings results and economic data that Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, said he found encouraging.

“Investors clearly have a lot to digest right now between the unknown consequences of sanctions, surging commodity prices, and the erratic ebb and flow of Fedspeak and U.S. data,” Orton said. With concerns about possible consequences of the war in Ukraine on the rise, “I think a lot of these extreme situations are impacting how investors feel and their overall willingness to be involved and to put money to work in the market.”

The average daily move of the S&P 500 Index so far this year stands at just over 1%, compared with the average move of 64 basis points last year. Intraday swings are even larger, averaging 2% year to date. This week will probably bring more of the same, Orton said, even with Federal Open Market Committee members in a blackout period in advance of the U.S. Federal Reserve’s meeting later this month. He said the key report to watch this week is the monthly read on consumer prices due on Thursday. Economists expect a 0.5% month over month increase in the core Consumer Price Index and a 7.5% increase year over year in consumer prices. An upside surprise will not sit well given the concerns over commodity prices and additional supply chain disruptions that have occurred over the past few weeks, he said.

Sentiment is also incredibly weak. “In fact, it’s downright awful,” Orton said. While he said extreme bearish sentiment is the market’s best attribute right now, the lack of upside follow-through is deteriorating the market’s long-term upward trend as time passes. Last week’s downside was expected after the rally off the market bottom on Feb. 24, he said, but it begs the question whether the market is done going down. Orton has said for weeks that we haven’t necessarily seen the absolute low in the market, and he added that if the S&P 500 fails to hold support this coming week in the 4200 area that will increase the odds that the low on Feb. 24 was just a temporary bottom and that a lower low in the neighborhood of 3830 increases in probability.

“I’m biased right now to believe that the market is acting mostly on emotion, and I continue to look for selective opportunities on setbacks,” Orton said. Consequently, he added, “this is not the time to own the broad market. It’s the time to look for specific sectors or companies to own. I’m also encouraged that breadth is slightly increasing, which further reinforces my current outlook.”

It’s easy to get wrapped up in the daily swings and acute pessimism that has taken over the market narrative, he said. This is magnified because the market has been very unkind, particularly to companies that have reported strong results and have still seen their share prices slide after an initial pop as general malaise has set in. This is contrasted by last week’s round of strong earnings from a range of consumer-facing companies, demonstrating that customers are willing and able to spend, even with the current inflationary pressures. These robust results highlight the resiliency of the consumer, Orton said. A major credit card company also released data that showed February U.S. payments volume was 145% of 2019’s volume for the same month — and five percentage points higher than in January, with spending rebounding in the month particularly for travel, entertainment, and fuel.

“I’m not sure why so many investors continue to be caught off guard by these earnings beats,” Orton said. “Quarter after quarter we’ve seen consumers able and willing to spend. Real-time data from money center banks as well as payments processors have shown incredibly strong transaction activity. Sure, consumer sentiment is at the lowest levels over the past 10 years. But as a general principle, I’ve always said it’s a good idea to watch what people do rather than what they say.”

U.S. households spent the past 12 years deleveraging and still sit on a significant pile of cash that has been accumulated since the start of the pandemic, Orton said. This provides a buffer against adverse shocks — something he said is underappreciated right now — and also supports the catch-up we’re seeing in services spending. And this doesn’t need to come at the expense of strength in goods demand.

Consumer delinquencies and household debt service
ratios remain near cycle lows

Consumer delinquencies and household debt service ratios remain near cycle lows

Source: Bloomberg, U.S. Federal Reserve, 12/31/21.

U.S. household debt service ratio

U.S. household debt service ratio

Source: Bloomberg, U.S. Federal Reserve, 12/31/21.

And consumers have seen a large increase in net worth
…with the largest relative increase accruing to the bottom 50%

And consumers have seen a large increase in net worth with the largest relative increase accruing to the bottom 50%

Source: Bloomberg, U.S. Federal Reserve, as of 10/31/21.

 

Even more encouraging, Orton said, is the ability of best-in-class retailers to effectively navigate through supply chain disruptions and wage inflation, consistently raising guidance. He said all this supports his belief that there are great opportunities for stock investors, and it’s nice to see active managers navigating the recent environment well. He said he continues to believe that investors should use downside opportunistically and lean up the market cap spectrum and into higher quality active managers.

That said, Orton noted that there are areas of the market he would not touch right now, and one of them is Europe. Two weeks ago, he said, European equities looked good, especially in their less-expensive (relative to the U.S.) value space. Then the EURO STOXX 50® Index dropped more than 10% in a week and the outlook flipped. We also saw the largest ever weekly outflow from European Union funds ever in U.S. dollars. European equities are consequently very oversold, he said, but there is no clarity with respect to the economic outlook.

“Things change,” Orton said. “You can’t be dogmatic with your approach to this market.”

What to watch

Orton said he expects the markets to continue to react to headlines this week, which also will bring some important data on inflation and consumer sentiment.

Monday China trade
Tuesday U.S. wholesale inventories and trade; Germany industrial output
Wednesday Japan gross domestic product; China Consumer Price Index and Producer Price Index
Thusday U.S. Consumer Price Index, U.S. jobless claims; European Central Bank rate decision; Japan Corporate Goods Price Index
Friday University of Michigan Index of Consumer Sentiment; U.K. monthly gross domestic product; Japan household spending

 

Risk Information:
Investing involves risk, including risk of loss.

Diversification does not ensure a profit or guarantee against loss.

Disclosures:
Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, or other expenses, which would reduce performance. Indexes are unmanaged. It is not possible to invest directly in an index. Any investor who attempts to mimic the performance of an index would incur fees and expenses that would reduce return.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature, or other purpose in any jurisdiction, nor is it a commitment from Carillon Tower Advisers or any of its affiliates to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical, and for illustration purposes only. This material does not contain sufficient information to support an investment decision, and you should not rely on it in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and make their own determinations together with their own professionals in those fields. Any forecasts, figures, opinions, or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions, and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements, and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

The views and opinions expressed are not necessarily those of the broker/dealer; or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules, and guidelines.

Basis points (bps) are measurements used in discussions of interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.

The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 households and 22,000 retailers.

The “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy,” known as “Core CPI,” is an aggregate of prices paid by urban consumers for a typical basket of goods, excluding food and energy. Core CPI is widely used by economists because food and energy have very volatile prices.

The China Consumer Price Index (CPI), released monthly by the National Bureau of Statistics of China, measures changes over time in prices of goods and services in eight categories and 268 basic divisions covering consumption by urban and rural residents, including food; tobacco and liquor; clothing; residential costs; household articles and services; transportation and communication; education, culture, and recreation; healthcare; and other articles and services.

The China Industrial Sector Producer Price Index (PPI) is released monthly by the National Bureau of Statistics of China and reflects the trend and level of prices change when the products are sold for the first time. The survey of industrial producers covers the prices of industrial products in 40 major industrial categories and more than 1,300 basic categories.

The Japan Corporate Goods Price Index, released monthly by the Bank of Japan, tracks producer prices, export prices, and import prices across a range of manufacturing industries and commodities.

The University of Michigan Index of Consumer Sentiment is based on monthly telephone surveys in which at least 500 consumers in the continental United States are asked 50 questions about what they think now and what their expectations are for their personal finances, business conditions, and buying conditions. Their responses are used to calculate monthly measures of consumer sentiment that can be compared to a base value of 100 set in 1966.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The EURO STOXX 50® Index is a blue-chip index designed to represent 50 of the largest companies from eight Eurozone countries: Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands, and Spain.

 

CTA22-0157 Exp. 7/7/2022