In our Monday reports, we always strive to first highlight what is most important for clients, but frankly, we debated what exactly that should be this morning. There was a long list of contenders… the breakout in global yields, the subtle weakness in USD, the momentum surge from the Banks, the strength out of the Energy stocks, the outperformance of Staples vs. Discretionary, the weakness in Software, the persistent selling of the market’s most speculative corners, or the breakdown in small-cap growth vs. value. The more we thought about it, the more we kept coming to the same conclusion – all of this is really the same story, and it reflects the significant leadership shift in process as 2022 gets underway.
The rate move is consequential… it’s global and it’s synchronized. U.S. 10’s are pushing up against 1.77%, and while they’re overbought, good trends have an affinity for powering through with nothing more than a modest pause or consolidation (the chart counts to roughly 2.40%, with near-term support at 1.65%). Swiss yields are > 0% for the first time in 3 years and German 10’s are right on the doorstep. As the timeline for Fed hikes has been pulled forward over the last few weeks, we take comfort that long rates have moved higher (along with some bear steepening) and Banks have outperformed – in the early days of a tightening cycle, neither should fall. Up roughly 10% in the first 5 trading days of the year, U.S. Bank stocks had their best absolute performance week since November of 2020 and their best week of relative outperformance vs. the S&P since 2009 (+1200 basis points). Joining the Banks on the relative high list was Energy, Machinery, and Air Freight… position in the direction of leadership, particularly when there is a scarcity of assets (there are only 22 Energy stocks in the S&P 500).
As higher rates have ignited a spark under the shorter duration pockets of the market, the most speculative groups remain weak. Small-cap growth vs. value is actually at 2-year lows (we’re not sure how many people realize this), and we’re curious if it foreshadows what to expect up the cap-scale.
Earnings Start This Week
Energy Sector Expected To Lead 4Q Revenue Growth
With the fourth quarter earnings season set to begin, we take a look at where expectations are for revenues to start the reporting season. The cyclical sectors of Energy, Materials, & Industrials are all expected to report revenues greater than the S&P 500, with Real Estate also expected to see strong sales growth. Financials is the lone sector estimated to see revenues decline by -5.0%.
4Q EPS Growth To Be Carried By Just 13% Of The Index
The story is similar on the earnings front, with energy growth rates extremely elevated as the sector laps the depths of the Covid crisis. Materials and Industrials are the only two other sectors expected to surpass the overall index. At 22.4%, the bar is relatively high for 4Q earnings growth especially since it is expected to be supported by just 13% of the index.
S&P 500 Operating Margins Stabilizing
We’ve written extensively about the importance of margins in order for the markets to remain in solid standing. Following the remarkable expansion for most of 2021, the turn lower toward year end was concerning but the good news is they have since stabilized. The extent to which margins are able to maintain a level near 17% would suggest to us that the market should be able to hold these levels. We will be watching this series closely for any signs of deterioration.
Keeping An Eye On Cost Growth
Costs continue to grow rapidly for the S&P 500 in aggregate and have now surpassed the cost growth seen in 2011. One positive, however, is that revenue growth continues to exceed cost growth, and as long as this occurs, we are not overly concerned. Should this change, it would warrant attention.
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by FactSet.
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