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The strong headline FT Wilshire returns do not reflect market undercurrents
Exhibit 1 shows the return profile for the FT Wilshire 5000 since the start of last year, showing how it has maintained an upward trajectory from the low reached last October. However, the 8.8% return for 2023 YTD (through to the end of May) belies the picture of a significant bifurcation between the winners and losers materializing below the surface.
Exhibit 1: The FT Wilshire 5000 has continued to trend higher from the October 2022 low
Source: Wilshire. Data as of May 31, 2023
Exhibit 2 compares the profile of the return for the headline FT Wilshire 5000 index YTD (red) versus the return of the FT Wilshire 5000 ex technology sectors (blue). Ex technology, the index has posted a negative -1.2% return YTD and shows a loss in momentum in Q2.
Exhibit 2: YTD the FT Wilshire 5000 Index ex technology sectors has declined -1.2%
Source: Wilshire. Data as of May 31, 2023
Exhibit 3 displays the sector weighted performance contributions to aggregate market returns for both Q2to date (dark blue) and YTD (light blue). The AI fueled rally in the tech sectors has seen them dominate return contributions over both periods.
Exhibit 3: Sector-weighted performance contributions to aggregate market returns
Source: Wilshire. Data as of May 31, 2023
Exhibit 4 shows the relative performance of the sub sectors within the FT Wilshire 5000 Technology industry group. It clearly shows the significant uplift in the relative performance of the Semiconductor sector in Q2 reflecting the focus on Nvidia Corp as a key AI beneficiary.
Exhibit 4: The Semiconductor sector has been the main AI trade beneficiary
Source: Wilshire. Data as of May 31, 2023
Exhibit 5 shows the combined weighting of the top 10 stocks within the FT Wilshire 5000 index over three time periods. The current combined weighting of 25.9% exceeds the level reached ten years ago and importantly the 20.3% weighting attained at the peak of the Technology, Media, and Telecoms (TMT) bubble in early 2000.
Exhibit 5: The top 10 stocks weighting now exceeds the TMT peak level.
Source: Wilshire. Data as of May 31, 2023
Exhibit 6 compares the return contribution generated by the top 10 stocks and compares them to the respective aggregate market returns. In the final year of the TMT bubble the market returned 24.1% with the top 10 stocks contributing 9% (over 1/3rd)of the aggregate return. So far in 2023 the market has returned 8.8% with the top 10 stocks contributing 8.4% (95%) of the aggregate return. In this respect the market is delivering the most concentrated returns this century.
Source: Wilshire. Data as of May 31, 2023
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As we approach the middle of the year increasing attention is given to the EPS outlook beyond year end 2023
When we gauge the US corporate EPS pulse there are signs of improvement but also caveats around the quality of the recovery.
Exhibit 1 shows the latest consensus 2023 and 2024 EPS growth rate projections across the regions. It also shows where these projections stood at the start of the year (dots). The US 2023 EPS growth forecasts have deteriorated and now stand at3.4%.
Is this the nadir? On a positive tack however, the 2024 EPS growth forecasts have improved and now stand at 13.4%.
We also show in Exhibit 3 following the latest Q1 EPS releases the 2023 and 2024 EPS estimate shave seen their first uptick in over a year.
Exhibit 1: The status of consensus regional EPS growth forecasts
Source: Wilshire and FactSet. Data as of May 17, 2023.
Exhibit 2 shows the 2023 and 2024 consensus top 10 US sector EPS growth rate projections. It also shows the sector weighted contributions that determine the aggregate level. Looking at the 2024 total market EPS growth rate projection of 13.4% ,3.4% of that growth (c.25%) is accounted for by contribution from the technology sector. However, as this is a similar sized contribution to that of 2023 the technology sector is not the main driver behind the 2024 improvement.
We highlight the financials, consumer durables, electronic technology, energy, and health technology sectors as the primary contributors to the improved outlook.
Exhibit 2: US top 10 sector 2023 & 2024 EPS growth rates and contributions.
Source: Wilshire and FactSet. Data as of May 17, 2023.
The EPS growth rate compares the EPS from one period against another. This is why when gauging the quality of the growth rate projections it is important to analyze the profile of the underlying EPS forecasts. Exhibit 3 shows the estimate trails for aggregate US consensus forecasts for 2023 and 2024.It shows that both series or estimates have declined from the start of the year ( 2023 by-6.5% and 2024 by -3.1%). This implies the improvement in the 2024 growth forecast (the gap between the two lines) has not been high quality as it is a function of the denominator series deteriorating at a faster rate.
Exhibit 3: The US 2023 and 2024 EPS estimate trails
Source: Wilshire and FactSet. Data as of May 17, 2023.
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2023 has witnessed some key inflection points and reversals in market behavior compared with the 2022
2023 has witnessed some key inflection points and reversals in market behavior compared with the 2022. One of the most notable shifts has been the resumption of deteriorating market performance dispersion. Exhibit 1 shows that 2022 saw the equally-weighted FT Wilshire 5000 significantly outperform the market cap weighted index but 2023 has seen this pattern reversed.
Exhibit 1: The Equally weighted index has started to underperform its market cap peer.
Source: FT Wilshire
Another gauge of market performance dispersion is the comparison between the return of the median stock with that of the aggregate return of the top ten stocks. Exhibit 2shows that 2022 saw the median stock outperform by c.10% but so far 2023 has seen a significant reversal with the top 10 stocks outperforming by more than 20%.
Exhibit 2: Comparing the performance of the median stock to that of the top 10 stocks
Source: FT Wilshire
Another key dynamic of market rotation in 2023 has been the reversal in Style performance.
Exhibits 3A &B3 show the scale of reversal in the Growth v Value and Large cap v Small cap relative performance in 2023 .
Exhibit 3A: 2023 has seen a strong rotation back to Growth style v Value
Source: FT Wilshire
Exhibit 3B: 2023 has seen a strong rotation back to Large cap v small cap style
Source: FT Wilshire
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An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) ...
An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) together with fears of further bank contagion is the degree to which these concerns impact broader economic confidence. There is some concern that recent high frequency economic data releases are pointing to a rapid loss of momentum. The debate about the risk of a recession is once again on the agenda.
The beginning of 2023 saw a strong recovery in US labour market and other key economic lead indicators. This created some anxiety in the Fed that this recovery was too rapid, and this saw a tightening of their reaction function. However, since the SVB collapse economic data has subsequently weakened at a rapid rate resulting in a significant lowering in year end rate forecasts.
Chart 1: After a strong start to 2023 US data has started to rapidly deteriorate.
Chart 2 shows the status of bank lending standard surveys for both large and small firms. Lending standards have spiked and are at levels that have only been exceeded three times this century. Given that US non-financial corporates have accumulated corporate debt at a 7.7% CAGR since 2011 taking the total from c. $6tn to $13tna tightening in lending standards marks an important inflection point in this trend. Weaning corporates off debt accumulation and financial engineering would constitute a major paradigm shift.
Chart 2: Bank lending standards have soared – a paradigm shift?
Despite lending standards tightening and real M2 money supply remaining deeply negative our US composite Financial Conditions Indicator has continued to move from restrictive to neutral. This has been driven partly by declines in both bond yields and real yields. In addition, the dramatic decline in US interest rate expectations has seen US interest rate differentials (versus other G7 economies) narrow. This has contributed to the decline in the dollar as can be seen in Chart 3.
Chart 3: Narrowing US interest rate differentials have contributed to the decline in the dollar
Source: Wilshire, Refinitiv, Factset and Federal Reserve. Data as of April 13, 2023
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The +7.3% return in Q1 was delivered in three distinct phases
Q1 returns were a function of 3 phases -A goldilocks rally in January (reflecting optimism that a recession would be avoided, and the Fed were almost done) followed by a sharp decline (from the start of February to mid-March) driven by concerns over both a hawkish Fed and bank contagion angst. Finally, late March saw a strong rally as the 'fear trade' dissipated.
Exhibit 1: The return for the FT Wilshire 5000 index
Source: Wilshire. Data as of March 31, 2023.
The collapse of Silicon Valley Bank (SVB) in early March generated global contagion angst resurrecting 2008 GFC redux risk aversion in markets. Exhibit 2 shows that US banks saw the largest relative performance decline compared to other regions in Q1.
Exhibit 2: The relative performance of the bank sector across the regions in Q1
Source: Refinitiv. Data as of March 31, 2023.
The market response to heightened bank contagion risk was to price in a big decline in year-end interest expectations (reflected in the decline in 2-year bond yields) and a weakening in real yields. Once contagion angst started to dissipate by mid-March, easing financial conditions became the key driver behind the subsequent rally in risk appetite that saw the FT Wilshire 5000 post a +2.7% return for the month.
Exhibit 3: 2-year bond yields declined sharply
Source: Factset. Data as of March 31, 2023.
Rather than the emergence of bank contagion concerns, the key feature of Q1 performance was the strength of the recovery in Technology stocks. Exhibit 4 shows the relative performance of the technology sector and the relative performance of the growth style versus value. The performance of technology and growth style (long duration equity trades) is closely correlated to movements in US real yields. The positive inflection in Q1 was connected to signs that US real yields had peaked.
Exhibit 4: The relative performance of the technology sector, Growth style vs real yields.
Source: Wilshire, Factset. Data as of March 31, 2023.
Exhibit 5 shows the sector-weighted performance contributions (the combined impact of sector weight and sector performance) for the FT Wilshire 5000 for Q1 vs the whole of 2022. The combined contributions for the technology and digital information sectors in Q1 accounted for the majority of the 7.3% for the index. This is a mirror opposite of the negative contributions they generated in 2022.
It can also be seen that the negative contribution for financials (this includes banks) was relatively small in Q1.
The tech rally trumped bank angst in Q1
Exhibit 5: The decomposition of market returns - 12months and YTD.
Source: Wilshire. Data as of March 31, 2023.
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Share buybacks in the US have been a key feature of market dynamics during the post-GFC period...
The environment of financial repression provided companies with the perfect tailwind to pursue buybacks that boost both EPS and shareholder returns. However, it appears that this secular driver has peaked and is losing momentum.
Chart 1: US (ex financials) quarterly and rolling 4Q buybacks (USD, Bn)
US buybacks (ex Financials) peaked at trailing 4-quarter rate of $1tn in Q3 last year and have eased back since. The opportunity to repurchase shares on a large scale has been rational behaviour for companies in the post-GFC landscape of extremely cheap money and rising free cashflow. However, with interest rates rising and profits declining, there will now surely be big question marks over companies' willingness to sustain buybacks at these levels.
Chart 2: US technology companies have been the dominant force behind US buybacks
Chart 2 shows the US sector buybacks as a percentage of total (ex financials) buybacks, demonstrating the dominance of the technology sector. Over the past decade technology has seen its share of buybacks rise from 20% to a peak of over 50% in mid-2021. The share of the next four biggest sectors has largely remained flat and range bound. With technology buybacks now in decline, there will be big question marks over which sectors, if any, will pick up the baton.
Chart 3: Comparing the US dividend yield with the buyback-adjusted yield
Chart 3 shows the impact on the effective yield returned to shareholders when buybacks are included. The buyback-adjusted yield rises to 4.3% (versus a 1.6% dividend yield). Compression in the adjusted yield will impact long term return projections.
Source: Wilshire and FactSet. Data as of March 13, 2023
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The collapse of Silicon Valley Bank (SVB) and fears of contagion have hit global bank stocks, rippling through to wider risk off market sentiment
The collapse of Silicon Valley Bank (SVB) and fears of contagion have hit global bank stocks, rippling through to wider risk off market sentiment. Recent events could well be the first of many unintended consequences of a rapid shift from ultra-accommodative to restrictive financial conditions.
Chart 1: Asset class returns since 7th March (SVB news)
Declines in global bank stocks and contagion concerns have rattled equity markets and economically sensitive assets such as oil since the news on SVB broke. This has also led to a flight to perceived safe-haven assets such as gold.
Chart 2: Regional bank sector returns since the SVB news
The collapse of SVB was initially seen as isolated to the US with the US banking sector experiencing the worst of the sell-off in the few days that followed the SVB news. Contagion fears soon led to a sell-off in banks globally, with particular concern over the value of bond portfolios held by many institutions. In recent days the focus has shifted on to European banks, with the spotlight on Credit Suisse which saw its shares plunge by a quarter on the 15th March. As Chart 2 shows Asian banks, which are seen as relatively well capitalised have held up well and only seen modest declines.
Chart 3: Contagion fears in the banking system have led to a dramatic decline in US year end 2023 rate expectations
The upshot of recent events has been the significant decline in US interest rate expectations. Markets had been ramping up rate expectations on the back of a sequence of strong economic data, pricing in a 50bps hike from the Fed at its March meeting. As the chart 3 shows, following recent events in the banking sector markets now expected the Fed to halt its tightening cycle, and are now in fact forecasting around 75bps of rate cuts by the end of the year to 3.9%.
Ultimately, the sharp fall in rate expectations could be an overreaction if the contagion proves to be limited. However recent events have created yet another conundrum for the Fed. SVB could be the first of many casualties to emerge as restrictive financial conditions start to take their toll.
Source: Wilshire, Refinitiv and Federal Reserve. Data as of March 15, 2023
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While the FT Wilshire 5000 adopted a risk off tone in February…
Having rallied in January on optimism that a recession would be avoided, the release of surprisingly strong labor market data forced the market to reappraise the trajectory of interest rates (dispelling any notion of them nudging lower later this year).This generated a cautious risk off tone that pushed the FT Wilshire 5000 -2.4% lower in February. However, the index is still up 4.4% YTD.
Exhibit 1: Risk aversion came to the fore in February driven by a rise in market interest rate forecasts
Source: Wilshire. Data as of February 28, 2023.
A key feature to the 2022 drawdown was the persistency of the decline in technology stocks. Interestingly, the February risk off move saw the technology sector outperform, delivering a positive sector weighted contribution to return (see Exhibit 2). In fact, year to date the technology and digital information and sectors have been the dominant positive contributions to aggregate returns. This is a mirror opposite to the 2022 dynamic.
Exhibit 2 : Sector weighted contributions to aggregate returns - YTD and February 2023
Source: Wilshire. Data as of February 28, 2023.
The positive inflection in the performance of the FT Wilshire Large Cap Growth index relative to Value that started in January persisted in February. This is a reversal of the 2022 dynamic (Exhibit 3). This rotation has occurred despite the rise in bond yields and real yields in February - these were key drags on highly valued Growth stocks in 2022.
Exhibit 3: Growth v Value style performance continues to inflect higher.
Source: Wilshire. Data as of February 28, 2023.
Exhibit 4 compares the performance of the top 10 stocks in the FT Wilshire 5000 to the performance of the median stock to gauge the degree of performance dispersion. 2022 saw the median stock outperform the top 10 stocks implying a widening of dispersion. However, 2022 year-to-date has seen the opposite occur with the top 10 stocks significantly outperforming the median stock. This narrowing of dispersion has marked the return to the dominance of the few that characterized the market prior to 2022.
Exhibit 4: Comparing the return generated by the top 10 stocks v the median stock
Source: Wilshire. Data as of February 28, 2023.
Exhibit 5 decomposes market returns drivers into the contribution from changes to dividends, changes to EPS forecasts and changes to valuation. In the case of the US market, over the last 12 months the negative return was mainly attributable to the significant decline in PE valuation (grey bar). In 2023 the opposite has occurred with the positive return been driven by the expansion in the PE multiple.
Exhibit 5: The decomposition of market returns - 12months and YTD
Source: Refinitiv. Data as of February 28, 2023.
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The improvement in risk appetite in recent months has been underpinned by a 'Goldilocks' scenario of easing financial conditions
The improvement in risk appetite in recent months has been underpinned by a 'Goldilocks' scenario of easing financial conditions, the prospect of a soft landing for the US economy and the expectation that US interest rates are close to peak levels. However, this may have all come too soon.
Chart 1: Have we now have hit a nadir in economic data?
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
The last few weeks have witnessed a succession of strong data releases. As Chart 1 shows this includes a sizeable rebound in the US ISM services index and the well-above expectation January non-farm payroll figures. The latter further confirming the resilience of the US labour market. Chinese PMIs have also inflected higher following the reopening of the economy post-Covid. Further signs of improving activity in the world's second largest economy will likely prove a boost to growth globally.
Chart 2: We have seen a sharp rise in US market interest rate expectations in recent weeks
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Chart 2 shows the latest US market interest rate curve out to the end of 2023 versus the curve at the end of January, before the release of the stellar non-farm payroll figures. The red line shows the Fed's current interest rate projections. As we can see, the recent sequence strong set of data has fed through to a marked rise in US market interest rate expectations. Markets now see rates peaking later at 5.25% in September (up from 4.9%) and the degree to which rates are expected to fall back has also eased significantly. Are markets now beginning to agree with the Fed's view that rates may have to stay higher for longer?
Chart 3: Total return decomposition shows PE re-rating as the key driver of returns-both on the way up and on the way down
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Chart 3 shows the total return decomposition for the US, UK and Europe ex UK, breaking the returns down by dividend and shifts in EPS and PE. We can see that last year's declines to the lows in October were driven by the PE de-rating, with EPS actually rising in the US and UK. Contrast this with the returns from the October lows to date and we can see a reversal of the 2022 profile, with a PE re-rating the main driver, while EPS in all three regions have declined.
Chart 4: US 2023 and 2024 EPS estimates have seen further downgrades since the market low in October
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Drilling further into the status of US EPS, a constant theme throughout the Goldilocks rally has been further downgrades to US EPS estimates. Chart 4 shows the progression of 2023 and 2024 EPS estimates since the start of last year. As the chart highlights, the market rally from the low in October has coincided with further downward revisions to analyst's EPS estimates, more pronounced in the 2023 numbers which have declined -7.5%. This has further magnified the (low quality) US 12-month forward PE re-rating we've seen since October we highlighted in Chart 3.
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