Lori Calvasina on Market 'Sticker Shock', Earnings Sentiment, and Small Caps

Market Outlook and Valuations

• ⚠️ RBC Capital Markets maintains a short-term cautious view while remaining constructive on the year ahead, anticipating a potential 5-10% market drawdown.
• 🎯 Valuations have been hitting a ceiling since August, contributing to a sense of 'sticker shock' in the market, with major indices and the broader market nearing typical highs.
• 💡 A pause that refreshes is expected and has been anticipated for some time, with the market potentially starting to experience this now.

Bitcoin as a Leading Indicator

• 📉 Bitcoin has shown pronounced weakness and choppiness, lurching downwards and correlating with the S&P 500, often seen as a gauge of retail investor sentiment.
• 🔄 While pullbacks in Bitcoin have preceded S&P 500 pullbacks, the market has often lurching back before a full correction materializes.

Small Caps and Economic Environment

• 📊 Small caps are viewed neutrally, partly due to RBC economists forecasting a 1-2% GDP growth for next year, indicating a fine but not hot economy.
• 🔑 Sustained small-cap outperformance typically requires more than just rate cuts; it needs a stronger economic backdrop like accelerating job growth or rising ISM manufacturing data.
• 📉 Hedge funds tend to temporarily invest in small caps during optimism about Fed cuts, but exit when that optimism fades, leaving a vacuum without a robust economic environment.

Earnings Sentiment and AI Impact

• 📈 While beat rates for earnings are good, the rate of upward revisions (earnings sentiment) has weakened, falling from a typical high in August to just above non-crisis lows.
• 🤖 The AI names (top 10 market cap) showed a major peak in earnings sentiment and are still decelerating, though they remain positive.
• 🛠️ Builders of AI technology sound optimistic, but users are still in the 'small potatoes' phase, with impacts that are not yet transformational for most consumer or healthcare companies.

Sector Specifics and Cautious Outlook

• 🏭 The industrial sector is noted as being expensive, with median P/Es on a forward basis showing a high z-score, even more so than the tech sector broadly.
• 📉 Consumer companies, particularly in staples and some discretionary areas, sounded lousy during earnings calls.
• ⚠️ The overall picture is cautious, with the need for a market drawdown, but not a disaster, and some lingering spookiness around the AI story.