Bottom Line: The rapid pace of the S&P rally to start the year is hard to sustain and some slowing in the pace of returns should be expected. Investor sentiment is above the 75th percentile relative to the breadth of data, suggesting lower than normal forward returns for the S&P on a 1/3/6-month basis. Given the outperformance of the lower volatility names and Mega caps, consolidation SHOULD be led by those groups, assuming inflation tail risks remain low. We expect inflation tail risks will remain low given the recent softening of economic demand indicators. Risk-on names will work in our view, on a relative basis, as the pace of the S&P index gains will slow.
Things to Watch [Consensus, Results]:
Portfolio Strategy: Sentiment Running Ahead of Economic Data Suggests a Slowing on Index Returns Ahead
Investor sentiment has perked up, outpacing the improving breadth of economic data. The spread between AAII net sentiment and our US AIM indicator, which is an aggregation of economic data improving/deteriorating from its prior reading, has reached its 75th percentile.
Forward returns for the S&P are worse than normal when the spread is at or above its 75th percentile. Worse data is better for risk-on internals because the Fed needs slower data, but our view on the overall index is muted. We don’t think the S&P as a whole moves higher with slower economic growth, as that is a tailwind for the average stock vs mega caps.
Quant: Focus on Profitable Small Caps for Better Risk Adjusted Returns
Small caps are trading at a deep discount to larger (large and mid) cap names, even if we exclude mega caps. The S&P 600 Index NTM PE spread with the S&P ex the top 100 market cap stocks is near the low end of its post-GFC era range. The spread reflects concerns towards the economic cycle and any evidence supporting the cycle extension should support small cap laggard catch-up (HERE). That helps explain the volatility between small vs. large cap names and recent small cap improvement in February.
One of the drags on small caps is the expanding proportion of the space that is unprofitable. The percentage of large cap S&P names that are unprofitable spiked during COVID but has moved lower as the global economy has recovered. The percentage of small caps with negative EBEX, however, has expanded in absolute terms and relative to larger cap names.
Breaking the S&P 600 into profitable and unprofitable groups shows returns for profitable names have been consistently stronger over time. We define profitability using trailing 12mo EBEX, rebalancing monthly to capture new earnings data. There are more sophisticated ways of parsing this universe, but the point we mean to illustrate is that focusing on profitability is a straightforward and easy-to-apply method of boosting returns within small caps. We have a list of these, if you are interested please don’t hesitate to reach out.
Source: FactSet, 22V Research
Technical Analysis: Chart Spotlight – XBI ETF
22V’s Technical analyst wanted to highlight that the S&P SPDR Biotech ETF (XBI) has been up for two weeks in a row gaining almost 6% and has gained in 10 of the last 12 weeks. Please see chart banner for further details and his technical scoring for the constituents below.
Source: 22V Research
