Markets in Focus

Timely analysis of market moves and sectors of opportunity

May 31, 2022: Bear market rallies are seductive. Proceed with caution.

Last week ended on a high note with strong gains throughout the week bringing U.S. equities into positive territory for the month of May. The Dow Jones Industrial Average surged 6.2% and snapped an eight-week decline, its longest losing streak since 1932, while the S&P 500 Index climbed 6.5% and the Nasdaq Composite Index jumped 6.8%. At the same time, last week also was the first time in a while that Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, advocated putting money to work given the market’s incredibly weak sentiment and stretched negative internals.

“It was a great reminder of why it’s so important to stay the course and put money to work even when it might feel painful,” Orton said. “Even though price action was encouraging, I emphasize caution with respect to chasing the market higher. I think now is the time to start to use downside again but more opportunistically to fill in asset allocation holes to get exposure to the market. What we saw last week confirms that we are in a bottoming process, but I expect to see a lot of chop in the near term.”

Quote Image
Since we aren’t in a bull market, we shouldn’t be positioned like we are in one.

Orton said it is important to remember that bear market rallies are very seductive as they pull you in but rarely do we see V-shaped recoveries without some exogenous catalyst such as dramatic policy changes from the U.S. Federal Reserve. Financial conditions are still tight, there’s still tremendous uncertainty with respect to inflation, and Orton said the market still needs to show it can absorb bad news and not totally fall apart.

“We can’t have total wipeouts in companies that miss earnings and good news needs to be rewarded,” he said.

But he said that if we continue to see strong improvement in breadth with sentiment moving off apocalyptic lows, there is scope to see a new uptrend develop as the market works through some of its current challenges. And Orton said there are opportunities from an asset allocation standpoint.

Still, last week’s price action was a reminder of why investors should avoid getting sucked into the rapidly changing market narrative, Orton said. At the start of last week the American consumer was all but dead, but results from a variety of retailers, ranging from a luxury department store to dollar store chains, showed wealthy and not-so-wealthy consumers were out spending in force. Orton has long maintained that the American consumer is doing well, even with inflation running hot, especially in energy and food. A strong labor force has provided insulation from these headwinds and Orton said he expects overall consumption to remain healthy until the labor market begins to crack. Savings are being drawn down meaningfully, he said, so it’s critical for the labor market to remain strong. So far, he noted, high-frequency data is corroborating that it is.

“So what areas of the market look interesting right now?” he said. “I might be stating the obvious, but since we’re not in a bull market, we shouldn’t be positioned like we are in one.”

That means maintaining a core defensive bias with a focus on higher dividends and dividend growth; high quality; and active fixed income, Orton said. This has worked well on a relative basis year to date, he said. However, if there are ups and downs during the bottoming process, Orton said the downs provide an opportunity to marginally add to higher beta parts of the market, such as high-quality software, to keep up when the market pops. In the very short-term Orton said he also is more neutral on small caps and is thinking that tactically reducing underweights to the space could help take advantage of any potential recovery.

A turn in equities, but will it hold?
Breadth and daily moving averages (DMA) in the S&P 500

A turn in equities, but will it hold? Breadth and daily moving averages (DMA) in the S&P 500

Breadth improved last week and for the first time since March, 20% of stocks were at four-week highs. A sustained turn would
confirm a new trend, Orton said. Meanwhile, he said he wouldn’t be surprised to see some short-term weakness, but markets overall
are still far from overbought.


Source: Bloomberg, as of 5/27/2022.

Last week’s rally wasn’t surprising

Even after the market strength last week, only 26% of the stocks in the Russell 3000® Index are trading above their 200-day daily moving average (DMA). There has been tremendous damage done to the market, which Orton said can provide a tailwind going forward. However, he noted, “it’s rarely a smooth ride.”

In addition to seeing continued gains in the market, Orton said he’s looking for high-yield credit spreads to stop widening — something that happened last week, “but they need to hold,” he said — for financial conditions to stop tightening, and for CEO confidence to start to improve or at least to moderate.

“If all of that starts to happen, I think that sets us up well very nicely for the second half of the year,” he said.

Orton on small caps: Neutral for now. Skeptical longer-term.

Orton has advocated maintaining an underweight small-cap position over the past eight months, notably due to the inherent lower-quality characteristics for smaller companies. And while he said he still views the Russell 2000® Index as an anti-quality index over the longer term and thus more convex to an economic downturn, he said he does think it looks tactically well-positioned for a relief rally.

“I still don’t like small caps in the long term,” he said. “There are a lot of headwinds for small caps and I still see them as an anti-quality pocket of the market, but they’re just so oversold. I’ve never seen positioning as negative in small caps as I have now. There’s been no flows into the space, and with flows starting to move into large-cap technology, small caps could be the next recipient of any dollars in motion. The valuation gap right now between small caps and large caps is the widest since the tech bubble burst, so that’s an area to be very tactical about and maybe add a little bit on the margin without increasing positioning too dramatically.”

Orton said the Russell 2000 ticks all the boxes from a short-term tactical perspective because it is:

  • More domestically focused, and thus faces less of a headwind from a strengthening dollar;
  • More tied to the economic cycle, where Orton said he believes recessionary fears are currently overdone; and
  • Incredibly stretched in terms of underweight or short positioning.

“Let me be clear,” Orton added. “I still don’t love the set-up of small caps longer-term, and anyone thinking about playing for a move higher should recognize the importance of being active and having a tactical focus on high quality. Beyond that, there’s just too much junk in the index that I would avoid at all costs.”

High-quality software and marginal beta exposure

Growth has reversed nearly all of its outperformance relative to value since the start of the COVID-19 pandemic while negative sentiment remains high and institutional positioning very light. That said, Orton noted that the valuation spread between growth and value still has room to normalize. This burden will not be equally borne across all companies, and he said he believes that further valuation compression will be concentrated in the lower quality, non-earning, and low free cash flow companies. We’ve already seen many high-quality names thrown out with the bathwater, he said, adding that those companies are where he would focus, especially in large caps and select mid caps with defensive characteristics. In particular, he said, software is less cyclical, and recent earnings across the group highlight the industry’s relative insulation from economic worries. While labor has the biggest exposure to inflationary forces, Orton said those costs are more easily controlled by management than input or energy costs. Software can also help investors position for a tactical rally but also provide some safety given many of these companies have seen extreme valuation compression, stronger earnings momentum, and are not crowded in terms of positioning, he said.

What to watch

“We get some good reads on the consumer this week and also data on the job market,” Orton said. In addition to some important economic data releases this week, scheduled earnings reports include companies in information technology; software; semiconductors; video games; cybersecurity; and food processing; plus retailers that sell lingerie; shoes; clothing; fashion accessories; athletic apparel; camping gear; and pet supplies.

This week's data releases

Monday Inflation reports for Spain and Germany
Tuesday U.S. Consumer Confidence Index; Canada gross domestic product; Inflation reports for the Eurozone, France, and Italy inflation; China Purchasing Manager Index
Wednesday Institute for Supply Management U.S. manufacturing Purchasing Managers’ Index; Job Openings and Labor Turnover Survey; U.S. Federal Reserve Beige Book; Canada rate decision, IHS Markit manufacturing Purchasing Managers’ Index for Canada; China Caixin Services Purchasing Managers Index
Thusday U.S. initial jobless claims; ADP® National Employment Report
Friday U.S. employment and nonfarm payrolls; Services ISM® Report on Business®

 

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.

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.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

Beta is a measure of the volatility or systemic risk of a security or portfolio compared with the market as a whole.

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.

A relative strength index (RSI) is a momentum indicator that tracks the magnitude of recent price changes to analyze overbought or oversold conditions in the price of a particular asset. Typically, RSI values of 70 or higher indicate that an asset is becoming overbought or overvalued. RSI values of 30 or below suggest oversold or undervalued conditions.

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

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

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.

Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price.

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.

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.

The price/earnings ratio (P/E) measures a company’s current share price relative to its per-share earnings.

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 Consumer Confidence Index (CCI) is a survey administered by The Conference Board that measures how optimistic or pessimistic consumers are regarding their expected financial situation.

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 Job Openings and Labor Turnover Survey (JOLTS) program produces monthly data on job openings, hires, and separations compiled by the U.S. Bureau of Labor Statistics.

Purchasing Managers’ Index data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies. PMI data features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as gross domestic product, inflation, exports, capacity utilization, employment, and inventories.

The China Caixin Services Purchasing Managers Index is compiled from responses to questionnaires sent to purchasing executives in over 400 private service sector companies.

The ADP® National Employment ReportTM is a monthly measure of the change in total U.S. nonfarm private employment derived from actual, anonymous payroll data of client companies served by the payroll, tax service and human resources management company ADP. The report measures changes within a group of nearly 26 million U.S. workers and is produced by the ADP Research Institute® in collaboration with Moody’s Analytics.

The Services ISM® Report on Business® is produced by the Institute for Supply Management (ISM) and is based on data compiled from purchasing and supply executives in a wide variety of industries nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month in supplier deliveries along with seasonally adjusted business activity, new orders, and employment.

The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange and the Nasdaq.

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 about 75% of the investable U.S. equity market.

The Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 97% of the total market capitalization of all U.S. incorporated equity securities.

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 Russell 1000® Growth Index measures a growth-oriented subset of the Russell 1000 Index, which tracks approximately 1,000 of the large-sized capitalization companies in the United States equities market.

The Russell 1000® Value Index measures a value-oriented subset of the Russell 1000® Index, which tracks approximately 1,000 of the large-sized capitalization companies in the U.S. equities market.

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.

 

CTA22-0345 Exp. 9/30/2022


May 23, 2022: A compelling long-term entry point for U.S. equities

Lackluster retail earnings added additional pressure to the market, with the S&P 500 Index dipping into official bear market territory on Friday before a late-session reversal left the index flat for the day, said Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers. The S&P 500 may not technically be in a bear market since it’s “only” down -18.7% from its January highs, but Orton said it’s a different story in the market of stocks with over 60% of index constituents down more than 20%. Additionally, the Nasdaq 100® Index and the Russell 2000® Index are down -28.6% and -27.4%, respectively, from their November highs, while growth stocks more broadly have been declining for the better part of 15 months; the MSCI World Growth Index has reversed nearly all of its post-COVID gains. Credit spreads have continued to widen as financial conditions tighten quickly. And last week’s obliteration of share prices for two major “big box” retailers following bleak earnings reports further crushed investor sentiment and deterred would-be dip buyers from wading back into the market.

“But,” Orton said, “we need to ask ourselves: Are things really that bad? Looking at investor sentiment, you would think unemployment was at 10% and the stock market was well into a bear market. The ferocity of the sell-off in retailers was extreme and is a reminder that there is zero tolerance by investors for any negative surprises.”

That said, Orton takes issue with the immediate change in tone of market prognosticators who now call for the demise of the consumer and are adding further fuel to negative sentiment. While last week’s major retail earnings were big disappointments and certainly highlight increased risks, the details of the shift in consumption habits aren’t all that surprising, he said. No doubt, Orton said, this is a very challenging business environment for retailers, with a lot of pressure on costs, exacerbated by rapid shifts in spending patterns. But overall consumption is on track for solid growth in the second quarter, and Orton said he expects it to remain healthy until the labor market begins to crack. Savings are being drawn down meaningfully, so it’s critical for the labor market to remain strong, and high frequency data is corroborating this strength, he said.

Additionally, there are a number of metrics that Orton said remain at incredibly stretched levels. Investor sentiment is still atrocious and institutional investors are more negative now on global growth than they were in March 2020, in the depths of the 2008-09 financial crisis, or even during the dot-com bubble crash. Cash levels are high and can get re-deployed once investors feel comfortable that the worst is behind us. All of this supports a bounce in equities should the macroeconomic data we get in coming weeks surprise positively, he said. However, the slow and steady rise of the S&P 500 since mid-2021 means that there is little technical support until the market gets back to the 3500 to 3600 range.

Signs of a bottoming process

Signs of a bottoming process

Source: Bloomberg and American Association of Individual Investors Sentiment Survey, as of 5/20/2022.

Advance/decline line signaling a reversal?

Advance/decline line signaling a reversal?

Source: Bloomberg, as of 5/20/2022.

Where to put money to work?

As stocks move further down, Orton said he feels increasingly comfortable starting to put money back to work. As he said, there certainly could be air pockets down to 3500 on the S&P 500, but with so much of the market already deeply into bear market territory and valuations back to 2018 levels when 10-year yields were above 3%, Orton said he believes this is a more compelling long-term entry point for U.S. equities. His areas of interest include:

  • Energy: Energy remains compelling for a more defensive positioning against rising inflation and energy costs, he said. U.S. energy in particular benefits from low supply, accelerating services demand, and the continued Russia-Ukraine war. He also said he favors lightening positioning to materials, which are susceptible to rising global recession risks as well as to continued strength in the U.S. dollar and overweight investor positioning.
  • Healthcare: Orton said he continues to favor healthcare for its defensive and counter-cyclical characteristics. First-quarter earnings were quite strong and the outlook remains favorable going into the second half of the year. While healthcare can protect in a falling market, he said its strong growth characteristics should still enable the sector to hold up should the market rally.
  • Focus on mid-caps: The Russell 2000 outperformed last week despite broader market challenges, but Orton said he still doesn’t favor small caps. Rather, Orton has written extensively on the case for mid caps, and he said he believes this current environment is a long-term opportunity for investors to lean into an asset class that has performed well during the drawdown this year and historically has outperformed in risk-on market environments. He said mid caps also ha ve a diverse exposure across sectors along with a much higher proportion of profitable companies than in the Russell 2000. “This quality bias will be key moving forward,” he said.
  • International is so bad … maybe it’s good? The bearish sentiment in international developed markets continues to prevail, especially for Europe where investor positioning remains incredibly short, Orton said. We saw yet another outflow from European equities last week, reaching 14 consecutive weeks of outflows. Sentiment remains terrible. Yet year to date the MSCI EAFE® (Net) Index is actually outperforming the S&P 500 after posting a strong week of relative performance. The MSCI EAFE (Net) Index is down -14.43% versus the S&P 500, which is down -17.67%. “It’s worth considering an international allocation for anyone looking to get more cyclicality in their portfolios,” Orton said, “but tread carefully.”
  • High-quality information technology: The sector is set to jump on any risk-on move, Orton said, but from a long-term perspective it’s important to own high-quality companies with durable earnings over the speculative tech names that could rally the most out of the gates. Valuations have normalized across many industries and companies with earnings and free cash flow are trading at compelling levels.

What to watch

On the surface, this might seem like a quiet week on the data front, but Orton said he believes some very important releases in the weeks ahead will shed light on how consumers are responding in the current inflation environment, namely:

  • How are wages performing relative to inflation? (Likely falling behind, Orton said.)
  • How aggressively are consumers tapping the $2.5 trillion of accumulated savings from the pandemic? (Orton said he expects the savings rate is moving sharply lower.)
  • And, finally, what does the distribution of spending between services and goods look like? (Retail sales data has pointed to strength in both categories, Orton said, but he added that he’s “a bit on edge” following last week’s major retail disappointments.)

This week's data releases

Monday U.S. Empire State Manufacturing Survey; ifo Institute Business Climate Index for Germany
Tuesday U.S. retail sales and industrial output; U.K. and Eurozone IHS Markit Flash Composite Purchasing Managers’ Indexes
Wednesday Mexico gross domestic product and economic activity
Thusday U.S. initial jobless claims; Federal Reserve Bank of Philadelphia Manufacturing Business Outlook Survey
Friday Tokyo Consumer Price Index, not including fresh food; China industrial profits

 

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.

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.

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

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.

The American Association of Individual Investors Sentiment Survey reflects answers offered each week by AAII members to the question: What direction do they feel the stock market will take in the next six months? Answers are sorted into bullish, neutral, and bearish categories.

The advance/decline line is a technical indicator that tracks the difference between the number of advancing and declining stocks on a daily basis. It is used to track market sentiment, confirm price trends in major indexes, and highlight the possibility of that a trend in trading could be heading for a reversal.

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 ifo Institute Business Climate Index for Germany is based on a monthly survey of about 9,000 firms in manufacturing, the services sector, and construction, plus wholesale and retail sales about their characterization of their current business and their expectations for the next six months. It is published by the ifo Institute for Economic Research, based in Munich.

IHS Markit Flash Composite Purchasing Managers’ Indexes (PMIs) are based on about 85% of the final number of replies received each month from a survey of a representative panel of private sector firms across individual countries in the European Union as well as the Eurozone as a whole.

The Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey is a monthly survey in which manufacturers in the Third Federal Reserve District, which includes Pennsylvania, New Jersey, and Delaware, indicate the direction of change in overall business activity and in various measures of activity at their plants: employment, working hours, new and unfilled orders, shipments, inventories, delivery times, prices paid, and prices received.

The Tokyo Consumer Price Index, excluding fresh food, is released by the Statistics Bureau of Japan and tracks a range of consumer prices in the Tokyo metropolis.

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® 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.

The MSCI World Growth Index captures large and mid-cap securities exhibiting overall growth style characteristics across 23 developed markets countries. 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, long-term historical EPS growth trend and long-term historical sales per share growth trend.

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.

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.

 

CTA22-0323 Exp. 9/23/2022


May 16, 2022: Look past the gloom and doom

It has been a brutal few weeks for investors as monetary tightening continues to put pressure on stocks and bonds, but last Friday’s reversal was timely and important, said Matt Orton, CFA, Chief Market Strategist for Carillon Tower Advisers. After a sharp correction, he noted, the day’s bounce had more than 90% of the volume going to advancing stocks.

“Whenever you see such strong demand coming off of a large market selloff, that tends to be a signal that we’re starting a bottoming process,” he said. “It’s rare to see sharp bottoms like we had in December 2018 and March 2020: Absent outside influence like actions by the U.S. Federal Reserve or a change in government policy, bottoming is a process, so just because we had a big bounce on Friday doesn’t mean we’ll get follow-through. That said, if we can hold 4000 in the S&P 500 Index, I think that bodes well for a gradual process of finding a bottom.”

Federal Reserve Chairman Jerome Powell’s admission on Wednesday that the U.S. economy might experience a “softish” landing gave further fuel to bears that equities might still be underpricing the risk of a recession, Orton said. After Friday’s rally, the S&P 500 is down just over 16% from its early January high while the Nasdaq Composite Index is down more than 25% from its November high. Investor sentiment remains abysmal, he said, but stretched pessimism hasn’t been enough to change the downward trajectory of the market. Many internal metrics are also at or near breaking points, hitting levels so low that Orton said they’re signaling a crisis in the market. Previous leaders such as mega-cap technology aren’t working but the market of stocks isn’t working, either. Both the cap-weighted S&P 500 and the S&P 500® Equal Weight Index are down nearly the same amount month to date and have tracked each other incredibly closely all year. It’s understandable that investors are throwing in the towel, Orton said, but he added that he would argue this is the absolute wrong time to do so. The market is already pricing in a very bearish cyclical outcome, and if a hard landing fails to materialize, there is scope for markets to react positively to a still robust earnings outlook in the second half of 2022, he said.

“We need to look past to doom and gloom because much of the pain has likely already been endured,” Orton said. “I don’t think that the doom and gloom that is being priced into the market right now is entirely justified given where we are, and especially with the strong earnings season we’ve just come from. We’re close to posting double digit earnings growth for this quarter, which is meaningfully higher than what we were expecting.”

Given that markets are signaling a crisis, Orton said it’s important to ask if we are really heading into one? Or is this just a normal bear correction within the context of a longer-term secular bull market?

“I would argue that we’re not in a crisis at this point,” Orton said. “We’re not heading into the same uncertainty accompanied by the complete economic shutdown and ensuing recession like we had during COVID and the economy is markedly healthier than during the Global Financial Crisis of 2008.”

While Orton said he has grown increasingly concerned about the price action over the past few weeks, he ultimately believes that we’re undergoing a necessary correction as the market adjusts to the realities of a rising-rate, post-pandemic world. Equity pessimism is incredibly stretched across the world. Bond pessimism is also stretched on a number of fronts globally, including within the U.S. and emerging market local currency bonds. Multiples have rapidly compressed and last week crossed below the 10-year average for the first time since April 2020 on the S&P 500. That’s thanks to both the rapid drawdown coupled with strong earnings, he said. In fact, he noted that first-quarter earnings have greatly exceeded expectations with a blended earnings growth rate of 9.1% for the S&P 500 (versus the 4.6% that had been expected). Margins have stayed above prepandemic levels, and expectations for the next two quarters have held up relatively well. There’s also no evidence that consumer spending is cracking, and Orton said this makes it difficult for him to succumb to the Cassandras of recession. If we can see the momentum of credit spread widening slow and a follow-through in the retrenchment of 10-year U.S. Treasury yields, he said he hopes that would help to stabilize flows and trigger more investors to start buying some of the sales in equities right now.

The overall market has been crushed with ‘crisis-level’ internals

The overall market has been crushed with ‘crisis-level’ internals

Source: Bloomberg, as of 5/13/22.

Valuations have compressed significantly

It’s getting more difficult to argue that markets are still expensive, Orton said. Multiples have compressed at a rate only previously seen in recessionary periods and forward price-to-earnings (P/E) multiples have reverted back to levels last seen in 2018 when 10-year rates were similarly above 3% and earnings were meaningfully lower than where we are today. Orton said he would argue that multiples have compressed too much overall, but the Nasdaq could still be at risk for further compression should the market continue to react so negatively to further rate increases.

Valuations have crossed below their 10-year averages

Valuations have crossed below their 10-year averages

Source: Bloomberg, as of 5/13/22.

The case for mid caps in a diversified portfolio

Orton noted that he has written extensively on the case for mid caps, particularly the favorable risk/return characteristics of this asset class. It’s worth highlighting, he said, that mid-caps have held up very well during the recent market volatility and are actually outperforming large caps by 50 basis points year to date and small caps by 431 basis points year to date. Risk-adjusted returns for mid caps also are higher than those for large and small caps, and Orton said this is consistent with long-term performance trends. Historically, he added, mid caps tend to outperform as markets bounce back, so he said he believes it makes a lot of sense to lean into mid-cap equities now.

U.S. equities vs. international

At face value, there’s not a lot to like overseas right now, Orton said. International developed and emerging markets have underperformed the U.S., but not by enough in his opinion to reflect the very different fundamental dynamics impacting each group’s economies. While inflation in the United States is largely driven by wages and demand, inflation overseas has been much more supply-driven; the result of the supply chain breakdowns and energy inflation which have been much more pronounced. Additionally, weak growth in China and continued lockdowns coupled with war in Ukraine make it difficult to handicap when these pressures will start to abate, he said. Further, the European Central Bank made a notable hawkish shift following its April meeting as inflationary pressures broaden and continue to accelerate. Economic sentiment has also crashed to levels comparable to those seen before the previous two ‘signaled’ recessions in early 2012 and the 2008 financial crisis. The German ZEW Financial Market Survey, an economic expectations measure, has recorded its largest fall on record, and consumer confidence has plummeted to COVIDcomparable lows. All of this make it more difficult to add weight to an international allocation right now, Orton said.

However, he added that there are some reasons for optimism that bear close watching. Ahead of the most awaited recession in recent history, European corporates have delivered another set of strong earnings. Revisions have slowed since last year, but nonetheless remain positive. Given crowded short positioning, Orton said he believes the risk-reward opportunity isn’t so bad. Investors have also reallocated to defensive sectors, driving international cyclicals to trade at historic discounts. Measures of equity risk premium remain very high, close to the levels seen during the height of the COVID-19 panic.

What to watch

Growth fears are likely to dominate this week with a busy calendar of economic data releases both in the United States and globally, Orton said. Another read on the American consumer will come from earnings reports from some critically important retailers and other companies working in home improvement and “big box” retail; department stores; discount retail; information technology; semiconductor materials engineering; cybersecurity; video game manufacturing; and heavy equipment manufacturing.

This week's data releases

Monday U.S. Empire State Manufacturing Survey; China industrial output and retail saless
Tuesday U.S. retail sales and industrial output; U.K. unemployment
Wednesday U.S. housing starts; Consumer Price Indexes from the U.K. and Eurozone; Gross domestic product reports from Japan and Russia
Thusday U.S. initial jobless claims, Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey; European Central Bank monetary-policy report; Australia employment
Friday U.K. retail sales; Japan Consumer Price Index

 

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.

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.

Blended earnings combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.

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.

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but different credit quality. Also referred to as “bond spreads” or “default spreads,” credit spreads are measured in basis points, with a 1% difference in yield equaling a spread of 100 basis points. Credit spreads reflect the risk of the debt security being compared with the Treasury bond, which is considered to be risk-free. Higher quality securities have a lower chance of the issuer defaulting. Lower quality securities have a higher chance of the issuer defaulting.

Forward or next-12-months prices/earnings ratio (NTM P/E) is a version of the ratio of price-to-earnings that uses forecasted earnings for the P/E calculation.

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%.

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.

The ZEW Financial Market Survey is produced monthly by the Zentrum für Europäische Wirtschaftsforschung (the Center for European Economic Research) and is based on a survey of about 350 economists and analysts on the economic future of Germany in the medium term.

Short is a term used to describe a strategy in which investors anticipate that prices of securities will fall in the short term, so, typically, they sell securities with plans to repurchase them later at a lower price.

Defensive stocks provide consistent dividends and stable earnings regardless whether the overall stock market is rising or falling. Companies with shares considered to be defensive tend to have a constant demand for their products or services and thus their operations are more stable during different phases of the business cycle.

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.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 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 core inflation by monitoring price changes in a wide variety of goods and services, excluding fresh foods but including energy, 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 S&P 500® Equal Weight Index is the equal-weight version of the S&P 500. It includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated a fixed weight, or 0.2% of the index total at each quarterly rebalance.

The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The Nasdaq 100® 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.

The Russell 3000® Index measures the performance of the 3,000 largest U.S.-traded stocks, which represent about 97% of the total market capitalization of all U.S. incorporated equity securities.

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.

 

CTA22-0314 Exp. 9/16/2022


May 9, 2022: Markets in a COVID time warp

Last week’s Federal Open Market Committee (FOMC) meeting dominated headlines in capital markets and rightfully so, said Sam Wells, CFA, Vice President and Portfolio Specialist at Carillon Tower Advisers. This was an opportunity for U.S. Federal Reserve Chairman Jerome Powell to regain control over the inflation narrative, after both current and former FOMC members have continued to ratchet up hawkish commentary in recent weeks. On the margin, Powell’s remarks could be interpreted as incrementally dovish since he pulled a potential 75-basis point hike off the table. But Wells said Powell’s comments did little to instill faith in a market that continues to grow more skeptical of the Fed’s inflation methodology framework.

“The post-FOMC day selloff is indicative of a market that does not believe the Fed has control of the situation,” he said. “The Federal Reserve’s credibility has been damaged as a result of its misguided inflationary forecasts and the lack of timely policy response over the last 18 months.”

Put simply, he said, current policy rates are not appropriate for an 8%-plus inflationary backdrop. The Fed remains behind the curve and as a result inflationary pressures continue to become more entrenched in the fabric of the global economy. This may ultimately result in much more aggressive monetary policy measures down the road, the prospects of which are likely at least partially responsible for the elevated volatility over the last few trading sessions.

Quote Image
Free money makes everything look interesting. We’re not in a free money regime anymore.

“The Fed has no good options left on the table, just tradeoffs,” Wells said. “It’s possible the Fed will be able to successfully navigate the allelusive soft landing, but it’s becoming increasingly difficult to consider that outcome a base-case scenario.”

Liquidity is very thin across asset classes, and Wells said he expects this will likely lead to big swings in both equities and interest rates in the weeks and months ahead. Over the next three months, the Fed is scheduled to ramp up the balance sheet run off at twice the peak rate in 2018. Market illiquidity will likely lead to elevated cross-asset class volatility, he said, just as it did in 2018. Given conditions are already quite oversold across asset classes, any potential dislocation is likely to lay the foundation for above-trend returns on a go-forward basis, assuming investors have dry powder and use flexible, multi-asset class approaches to investing.

COVID's continuing impact on markets

While broad fixed-income indices are down the most in 40 years year to date, these mark-to-market losses are purely interest-rate driven, said James Camp, CFA, Managing Director of Fixed Income and Strategic Income at Eagle Asset Management, an affiliate of Carillon Tower Advisers.

They’re not credit events, he said, but rather are a by-product of an economy and a market put into hyperdrive by the aggressive fiscal and monetary response to the COVID-19 pandemic.

What the pandemic did, Camp said, was compress time. Both the 2020 recession and recovery were the fastest on record, the fiscal and monetary responses were unprecedented, and those produced the fastest-ever acceleration in inflation. What will bring inflation down is a reduction in aggregate demand, he said, and a deceleration from rapidly rising inflation inevitably will jar markets.

“We ripped the bandage off very, very quickly, and it’s been very painful,” he said. “What I find fascinating about these periods is that all the darling investments that come up in a bull market and with low interest rates — think NFTs, think crypto, think aspirational tech — they all get destroyed. Free money makes everything look interesting. We’re not in a free-money regime anymore. The U.S. had the highest degree of fiscal and monetary stimulus in the developed world. We have the highest inflation rate in the developed world. Those two should not surprise anybody.”

Camp said this also means that the current market turbulence is less a reflection of longer-term macroeconomic trends than previous downturns.

“I do not believe that we are in a secularly reflated economy,” he said. “We are in a moment because we overstimulated after a recession of choice, and we just have to get that right. We have to unwind all that. But this does not mean three to five years from now that we’re going to have a Consumer Price Index at 8%. This is a window. You had a recession that lasted a month. You had $9 trillion thrown in the economy. You had everybody that went home and started spending, pushing aggregate demand off the chart. You had supply chain problems. All of that happened because of a medical emergency, not because of secular trends.”

Earnings are solid. Guidance, not so much.

As of Friday, 87% of the S&P 500 Index had reported earnings, with 79% of companies that have reported beating earnings expectations. The 5-year average beat rate has been 77%, so this has been a strong quarter relative to expectations. Moreover, earnings revisions for both U.S. and European companies are back into positive territory.

Still, many stocks are deeply negative in the wake of strong earnings. While macroeconomic headwinds (e.g., inflation, a hawkish Fed, the tight labor market, low housing affordability, tight liquidity, the Russia-Ukraine war, China lockdowns, etc.) are arguably the biggest driver of the deterioration in investor sentiment, Wells noted that earnings guidance also has been quite poor. Of the companies that have updated guidance, 69% have issued negative forward guidance. It’s no surprise that input costs, inflationary pressures, and the inability to source materials in a timely fashion are common challenges noted by most companies.

Consumer spending is key to growth — and shows some signs of softening

While most economic data releases point to a marked slowdown in growth, there are still a few areas of strength, most notably capital expenditures and the consumer. Many earnings calls have pointed to strong consumer trends this quarter, which is encouraging given how important the consumer is to economic growth (accounting for roughly two-thirds of U.S. real gross domestic product growth). It’s hard to argue that the consumer is not in good shape currently, Wells said. The unemployment rate remains near record lows. Various measures of spending remain at very healthy levels (although have decelerated since the fourth quarter of 2021). High-frequency indicators like mobility, airport security checkpoint counts, and online restaurant reservations suggest strength in services and the willingness and ability of people to get out and spend. Delinquency rates on all types of consumer loans remain near record lows. That said, Wells said a few recent economic releases suggest that consumers are less healthy than they were six to 12 months ago. To be clear, he said, there are no alarm bells (or if there are, they are very faint) pointing to a demand-driven slowdown, outside of tighter monetary policy which will inevitably have an impact on the labor market. Rather, he said the recent deceleration in three sets of data in particular bears watching in the months ahead to see if any trends materialize.

First, he noted, personal savings are back to pre-pandemic levels. Current savings levels are not unhealthy by any stretch, but the deluge of stimulus over the past two years is gone. The consumer blew through about $5 trillion in savings and now has far less dry powder to keep the economy pumping.

U.S. Personal Savings
Healthy, but off its pandemic peak

U.S. Personal Savings Healthy, but off its pandemic peak

Source: Bloomberg, U.S. Bureau of Economic Analysis, as of 3/31/2022.

Second, Wells said one of the more interesting economic releases last week was the Federal Reserve’s report on consumer credit. Of note, total consumer credit, especially revolving variety, increased at the fastest rate on record. Combined with consumers’ drawdown of stimulus payments, Wells said it’s evident that consumers are no longer flush with cash.

A spike in revolving consumer credit

A spike in revolving consumer credit

Source: Bloomberg, U.S. Federal Reserve, as of 3/31/2022.

Third, while wage growth has undoubtedly been a bright spot for consumers, the impact of inflation has more than offset the growth in wages. In fact, real weekly earnings — that is, earnings after inflation — have been negative for 12 consecutive months. Either inflation has to abate, wages need to move much higher, or some combination of the two, Wells said.

U.S. Real Average Weekly Earnings on a 12-month decline

U.S. Real Average Weekly Earnings on a 12-month decline

Source: Bloomberg, U.S. Bureau of Labor Statistics, Federal Reserve, as of 3/31/2022.

Wells said it’s worth noting that the consumer discretionary sector has had the largest percentage of earnings misses in the S&P 500 so far this quarter. Trends in the labor market and spending are arguably some of the most important indicators to follow for the remainder of the year as the consumer will determine whether we experience a correction or a more protracted downturn.

The bursting of the "spec" bubble continues

Within the larger rout in speculative tech companies, Wells said spec healthcare is an area that has gotten absolutely clobbered. For example, the biotech industry in the Russell 2000® Index is down about 65% from its peak in February 2021. Notably, a record number of biotech companies in the Nasdaq Biotechnology Index now trade below their cash value. Valuations may be interesting for longterm investors, he said, but it’s likely to be choppy in the near term. Negative sentiment and the weak macroeconomic backdrop will likely place stress on this industry in the near term.

Active management continues to work

After a challenging March, active management came back into favor in April. At least 50% of managers in each style box category beat the benchmark, with the manager win rate at 70% or higher in six out of nine U.S. style boxes. Wells said this trend is encouraging and should continue to hold as the current set of risk factors continue to weigh on lower quality/speculative stocks, a space in which most active managers have a sizeable underweight.

Active management during April

Value Blend Growth
Large 58% 91% 53%
Mid 70% 80% 56%
Small 81% 90% 70%

Source: Morningstar, as of 4/30/2022.

The large, mid, and small categories shown here represent core Russell market-cap indices — the Russell Top 200® Index for large, the Russell Midcap Index for mid, and the Russell 2000® Index for small — as well as each indice’s growth and value sub-indices.

What to watch

This is a big week for economic data releases, most notably the U.S. Consumer Price Index and Producers Price Index releases on Wednesday and Thursday, respectively. We should see inflation slow down on both a year-over-year and month-over-month basis, Wells said, but if these readings show a continued heating in inflation, expect the hawkish rhetoric to ratchet up even further.

This week's data releases

Monday U.S. wholesale inventories
Tuesday National Federation of Independent Business Index of Small Business Optimism
Wednesday U.S. Consumer Price Index; Eurozone Harmonised Index of Consumer Prices; Mortgage Bankers Association Mortgage Applications report; Real average hourly earnings
Thusday U.S. Producers Price Index; U.S. weekly jobless claims; U.K. gross domestic product
Friday U.S. Import and Export Price Indexes, 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.

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.

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%.

A policy interest rate is an interest rate set by a central bank or other monetary authority to influence the evolution of an economy’s monetary variables such as consumer prices, exchange rates, or credit expansion.

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

Mark to market is a method of measuring the fair value of assets, liabilities, or other accounts that can fluctuate over time. Mark to market strives to provide a realistic appraisal of a company or institution’s current financial circumstances based on current market conditions. During volatile markets, however, mark-to-market measurements may not accurately represent an asset’s true value in an otherwise orderly market.

An NFT, which is short for non-fungible token, is a unique cryptographic asset, including images, other works of art, or property rights, on a blockchain with unique identification codes and metadata that distinguishes it from any other asset and ensures that it cannot be replicated.

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.

Real earnings, also known as real income or real wages, reflect how much money an individual or entity makes after accounting for inflation. Unlike nominal earnings, which are not adjusted for inflation, real earnings better reflect the earner’s actual purchasing power.

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 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 National Federation of Independent Business Index of Small Business Optimism consists of 10 equally weighted and seasonally adjusted variables. The monthly change of each variable contributes proportionally to the overall monthly change in the index.

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 Mortgage Bankers Association Weekly Applications report covers mortgage application activity that includes purchase, refinance, conventional, and government application data, weekly data on mortgage rates, and indices covering fixed-rate, adjustable, conventional, and government loans for purchases and refinances.

The U.S. Import and Export Price Indexes measure the changes in prices of imported goods and services purchased from abroad by U.S. companies and businesses and exported goods and services sold to foreign buyers. The indexes cover prices of non-military goods and services and are published by the U.S. Bureau of Labor Statistics’ International Price Program.

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 Nasdaq Biotechnology Index contains securities of Nasdaq-listed companies classified according to the Industry Classification Benchmark as either Biotechnology or Pharmaceuticals which also meet other eligibility criteria. The Nasdaq Biotechnology Index is calculated under a modified capitalization-weighted methodology.

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 Russell 2000® Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower priceto-book ratios and lower forecasted growth values.

The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap represents approximately 26% of the total market capitalization of the Russell 1000 companies.

The Russell Midcap® Growth Index measures the performance of the midcap growth segment of the U.S. equity universe. It includes those Russell Midcap® Index companies with higher price-to-book ratios and higher forecasted growth values.

The Russell Midcap® Value Index measures the performance of the midcap value segment of the US equity universe. It includes those Russell Midcap® Index companies with lower price-to-book ratios and lower forecasted growth values.

The Russell Top 200® Index measures the performance of the 200® largest companies in the Russell 3000® Index, which represents approximately 67% of the total market capitalization of the Russell 3000® Index.

The Russell Top 200® Growth Index offers measures the performance of the especially large cap segment of the U.S. equity universe represented by stocks in the largest 200 by market cap. It includes Russell Top 200® Index companies with higher growth earning potential as defined by Russell’s leading style methodology.

The Russell Top 200® Value Index measures the performance of the especially large cap segment of the US equity universe represented by stocks in the largest 200 by market cap that exhibit value characteristics. It includes Russell Top 200® companies that are considered more value oriented relative to the overall market as defined by Russell’s leading style methodology.

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.

 

CTA22-0309 Exp. 9/9/2022


May 2, 2022: Many April showers, spotty May flowers?

April historically has been a strong month for equities, with the worst monthly return over the past decade being only -0.75% — until now. We’re starting May coming off the worst month for equities in more than two years, with the S&P 500 Index down -8.8% and the Nasdaq Composite Index down -13.3%. Friday in particular was painful as the S&P 500 moved well below the recent 4200 resistance level and set a new year-to-date closing low. It also was the worst April in history for small caps with the Russell 2000® Index down -9.9%: the group’s second-worst start to the year, after 2020.

Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, said he remains cautious this week as more tech heavyweights step into the earnings confessional, the U.S. Federal Reserve meets, and a host of important economic reports arrive. Yet while there remain a number of near-term headwinds — including abysmal investor sentiment, weak internals, and continued uncertainty with respect to monetary policy — he said there are still reasons to be optimistic as we push into the second half of the year. They include:

  • The consumer’s balance sheet ballast: Strong U.S. household balance sheets are a distinctive and growth-supportive feature of this expansion. Earnings season has highlighted the strength and the ability of the consumer to weather price increases across both goods and services. After all, the government legislated about $5.5 trillion of fiscal support over the course of the pandemic, with most of it going to households. Most households still have sufficient excess cash balances to weather an energy price shock and current level of inflation, though the bottom income quintile is on shakiest ground. “No matter how many times you hear people talk on the news about the consumer not being good, I have yet to see a single terrible earnings report where companies haven’t been able to pass along pricing to consumers and where they’re seeing a pickup in elasticity of demand,” Orton said. “There’s a lot of strong tailwinds coming from the consumer that I think can last at least until the end of this year.”
  • Earnings have been strong: Blended earnings growth for the S&P 500 sits at 7.1% (vs. 4.7% expected) with 80% of companies that have reported so far beating expectations. It’s worth noting that we’re seeing growth amid very difficult comparables as well as macroeconomic headwinds including higher costs, supply chain disruptions, labor shortages, and the war in Ukraine. It’s worth highlighting that the blended net profit margin sits at 12.2%, highlighting the resiliency of corporations in spite of all the aforementioned challenges. “That’s better than what we expected coming into the quarter and higher than we were before the COVID pandemic,” Orton said. “This is very important, because it shows that even with labor inflation, goods inflation, and supply chain disruptions you continue to see corporations doing well, and guidance, critically, has been pretty good from a lot of management teams. I believe that the first and second quarters are probably going to be the worst from an inflationary cost standpoint for companies, so we’re beginning to see a light at the end of the tunnel.”
  • Unemployment remains historically low: The labor market remains incredibly strong, with unemployment sitting at 3.6% and many more job openings than job seekers. Real wage growth has actually been positive for the lowest wage earners, helping to sustain their current level of spending. However, he said there comes a point where this strength is also a problem: The Employment Cost Index data last week was surprisingly strong and feeds into inflationary pressures already being exacerbated by more shutdowns in China.

“You can’t overlook these three factors,” Orton said. “These are huge drivers of the overall economy.”

Still, Orton said caution is warranted in the near-term even if we see a relief rally after the Federal Open Market Committee (FOMC) meeting this week. We had a lot of April showers, but it’s unclear whether they will bring May flowers for the market. If they do, Orton said it will likely only be in select companies and parts of the market where stronger fundamentals have been thrown out with the bathwater. That said, Orton said he believes there are plenty of these and some long-term opportunities in areas such as high-quality information technology and healthcare.

“The good news is that active management has been working, and I believe the focus on quality and solid fundamentals will help managers continue to shine,” he said.

Investor sentiment remains apocalyptic
Ratio of bulls to bears is the lowest since March 9, 2009

Investor sentiment remains apocalyptic Ratio of bulls to bears is the lowest since March 9, 2009

Source: Bloomberg, American Association of Individual Investors Sentiment Survey, as of 4/29/22.

Duration destruction

For tech investors, it’s been the worst start to the year in two decades. The Nasdaq 100® Index wiped out $1.8 trillion in value in April alone as investors feared an economic slowdown and evermore aggressive expectations around the Fed’s rate-hike trajectory. Disappointing earnings from two heavyweight companies also have weighed heavily on investor sentiment, especially around what is perceived as the higher-duration parts of the market. Consequently, the Nasdaq is now in a bear market, off 24% from its high. And with another hike in the Federal Reserve’s interest rate seen next week, Orton said he expects we’ll have more volatility over the coming weeks.

Volatility has spiked
Percentage of days Nasdaq has moved +/- 2%

Volatility has spiked Percentage of days Nasdaq has moved +/- 2%

Source: Bloomberg, as of 4/29/22.

Yet outside of a few disappointments, Orton said it’s clear from recent earnings that the information technology sector is doing well. In particular, he said we’re seeing strength from enterprise software and many higher-quality technology companies. These companies also can perform well during inflationary market environments, and Orton said one software CEO put it best: “Software is just about the only deflationary force out there.” But the pressure from rising yields and uncertainty around the pace of rate hikes continues to hit the sector. Given the strength in earnings (for the most part), Orton said he believes that the sell-off has been driven by duration rather than fundamental risks. The issue is that there are still too many companies with valuations over 50x earnings. This is why Orton said he continues to prefer “prime tech” over “spec tech” going forward and believes there are some noteworthy opportunities now.

Orton said it’s also worth highlighting that while consumer discretionary was a notable laggard last week along with IT and communication services, most of the sector is actually holding up pretty well. Just two of the biggest companies, which together comprise about 45% of the S&P 500’s consumer discretionary sector, are responsible for about 62% and 28%, respectively, of the sector’s April decline in terms of index points. Travel and leisure did well and we’ll hear from a number of key companies exposed to travel this week. Orton said he remains optimistic on companies with exposure to the U.S. consumer, and this price action is a reminder why we always need to look beneath the surface. It’s also a reminder of why active management has been working well this year.

Active management is working

“You can can’t eat relative performance, and the market weakness year to date is certainly painful,” Orton said, “but if there is a silver lining, it’s that active management has been working across market capitalizations.”

We came into this year believing that fundamentals were going to increasingly matter, and we’re seeing that play out, he said. Dispersion has increased across the market, enabling active managers to add alpha for clients. Overall, the percentage of managers beating their index was 70% in April; 51% for the last three months (as of April 29); and 60% year to date, according to data from FactSet; Lipper Analytical Services, FTSE Russell; and Jefferies. But Orton noted that the percentages were larger down the market-cap spectrum: In small caps, 93% of managers beat their core indexes in April; 74% over the last three months; and 90% year to date.

“Active management has been working very well in the small-cap space,” Orton said. “Active managers have been outperforming in general, but they’ve been working particularly well down the marketcap spectrum, just because there’s so much dispersion between different sectors and quality within companies.”

What to watch

Many markets in Europe and Asia were closed on Monday, and Japan is taking three days off from Tuesday through Thursday. But Orton said there is plenty happening in the U.S. between the meeting of the Federal Open Market Committee and earnings from companies in online travel; hotels, resorts, and entertainment; consumer staples; digital payments; phosphate mining; pharmaceuticals and biotechnology; petroleum; semiconductors; online vacation rentals; coffee shops; car services; pharmacies and health insurance; online retailing; cybersecurity; restaurants; beer; electric vehicle manufacturing; food delivery; sports equipment and apparel; managed healthcare; and sports betting.

This week's data releases

Monday Japan consumer confidence
Tuesday U.S. IHS Markit manufacturing Purchasing Managers’ IndexTM, plus factory orders, durable goods, and light vehicle sales
Wednesday U.S. interest rate decision
Thusday U.S. initial jobless claims; U.K. interest rate decision; France industrial output; Germany factory orders
Friday U.S. unemployment and payrolls; Consumer price indexes from Japan and Taiwan

 

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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.

A quintile is a statistical value representing 20% of a given set of data. The first, or lowest, quintile represents the lowest fifth of the data (1% to 20%), and the highest quintile represents the top fith (81% to 100%).

Blended earnings growth rates combine actual results for companies that have reported earnings and estimated results for companies that have yet to report.

A blended net profit margin combines actual net profit margins from companies that have reported earnings and estimated margins for companies that have yet to report.

The Employment Cost Index measures the change in the cost of labor, free from the influence of employment shifts among occupations and industries, for three- and 12-month periods. The U.S. Bureau of Labor Statistics collects data for the index from thousands of private and government employers nationwide.

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. Investors and market analysts watch certain yield curves for signs of inversion, when yields for longer-term debt instruments fall below yields on short-term debt with the same credit quality. Inversions are watched as potential signs of a weakening economy and in certain cases, a harbinger of recessions.

The American Association of Individual Investors Sentiment Survey reflects answers offered each week by AAII members to the question: What direction do they feel the stock market will take in the next six months? Answers are sorted into bullish, neutral, and bearish categories.

Equity duration is the cash-flow weighted average time at which investors can expect to receive the cash flows from their investment in a company’s stock. Long-duration stocks include fast-growing technology companies, including those that may not pay any dividends in their early years, while short-duration stocks tend to be more mature companies with higher ratios to dividend to price.

Alpha is a measure of the difference between a manager’s actual returns and its expected performance, given its level of risk as measured by Beta. A positive Alpha figure indicates the manager has performed better than its Beta would predict. A negative Alpha indicates the manager performed worse than expected based on its level of risk. Thus it is possible for a manager to outperform an index and still have a negative Alpha. In general, however, the higher the Alpha the better.

Beta is a measure of the volatility or systemic risk of a security or portfolio compared with the market as a whole.

Purchasing Managers’ Index data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies. PMI data features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as gross domestic product, inflation, exports, capacity utilization, employment, and inventories.

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

The Taiwan Consumer Price Index, released monthly by the National Statistics Bureau of the Republic of China (Taiwan), tracks prices paid by Taiwanese consumers for a wide range of goods and services.

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 Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The Nasdaq 100® 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.

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.

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