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After a tumultuous January for U.S. stocks, analysts at RBC Capital Markets have spotted some “good things” in equities amid investor concern over high valuations and the Federal Reserve’s pivot toward tightening monetary policy in the face of high inflation.
There are five “big things you need to know,” RBC analysts, led by head of U.S. equity strategy Lori Calvasina, said in a research note Monday. First, earnings-per-share forecasts for this year and 2023 have been “holding steady,” they said, even as “it clearly hasn’t been a great reporting season in terms of stock price reactions.”
Also, the contraction in the S&P 500 index’s forward price-to-earnings multiple is “in line” with the Fed’s past tightening cycles, they said, while the valuation gap between the most and least expensive stocks is nearing pre-pandemic levels.
“Another way to think about the recent turmoil is through the lens of the rotation out of overvalued growth stocks, which were bid up not only due to easy monetary policy but due to the pandemic,” the analysts wrote. “The hit to the economy that it created and the change in working and personal lifestyles” during the COVID-19 pandemic helped boost the fundamental case for them, they said.
The S&P 500
SPX,
has fallen around 6% this month, after soaring about 27% in 2021 amid some investors’ concern that loose monetary policy was fueling a melt-up in the U.S. stock market.
Sentiment among individual investors has fallen back to pandemic lows, which the RBC equity analysts counted among the “good things” they see in market data. They also pointed to asset managers’ small-cap futures positioning falling near where it bottomed in March 2020 as another good sign.
“Small-caps are often treated as pure plays on macro hopes and fears and their rough start to the year has been one of the things that’s unsettled us the most,” the analysts said. “Small-caps are very close to looking oversold.”
The Russell 2000 index
RUT,
a gauge of small-cap equities, has fallen around 10% this month, based on trading Monday afternoon, according to FactSet data. That’s after rising about 14% in 2021. The index entered a bear market last week, having fallen more than 20% from its record finish in November.
While small-cap futures positioning “isn’t close yet to historic lows” seen around the global financial crisis of 2008 and the earnings recession of 2015-2016, it is close to the March 2020 lows when it “entered net short territory for a very brief period of time,” the analysts said, citing data tracked by the Commodity Futures Trading Commission.
The U.S. stock market was rallying Monday afternoon, with the Russell 2000 posting a sharp 2.4% gain.
The technology-heavy Nasdaq Composite Index
COMP,
also was up sharply, with a 2.7% gain, while the S&P 500 was trading 1.4% higher and the Dow Jones Industrial Average
DJIA,
was up 0.7%. Still, all three major stock benchmarks have sunk in January, with the Nasdaq on track for a monthly loss of around 10%.
Despite a rough start this year for equities, real U.S. gross domestic product should increase 3.8% in 2022 and grow 2.5% in 2023 based on consensus forecasts, according to the RBC report.
“Since the financial crisis, growth scares have been accompanied by drawdowns of as little as 14.2% to as much as 19.8%,” the RBC equity analysts said. “All of these have represented buying opportunities, with above-average returns seen in the next 12 months that follow.”
Meanwhile, individual investor sentiment has soured to -17.4% on a four-week average, “officially crossing our ‘buy signal’ threshold,” the analysts said. “Sentiment may have already reached extreme pessimistic levels.”
With about a third of S&P 500 companies having reported earnings results for the fourth quarter of 2021, the “bottom up forecast” for the index’s earnings per share is still tracking at $224 for 2022, the analysts said. That’s “identical” to the reading seen in the middle of this month, while 2023 is tracking at $247, or up $1 from mid-January’s reading, according to their research report.
“Overall, there was some resiliency in bottom up earnings forecasts that emerged last week that’s important to take note of,” they said. “For now, this is a comforting data point and helps explain why, despite the severe intraday swings in stocks throughout last week, the S&P 500 appears to be trying to stabilize.”
RBC has a price target of 5,050 for the S&P 500 this year.
“To those wondering if we think we need to cut our year-end target, our answer is no, not right now,” the analysts said.
