Larry’s Thoughts: Welcome to this inaugural installment of Noteworthy Notes, where each week we select and summarize recent investment research from third-party analysts, wealth management firms and investment banks.
Our goal? We seek to align Wealth Solutions Report readers with the latest insights on the economy, the markets, specific industry sectors and securities from experts who have something unique to share.
This week’s Noteworthy Notes is from Jackson Square Capital, a San Francisco-based independent RIA firm that takes a hands-on approach to wealth management.
With over $330 million in client assets, Jackson Square Capital’s flagship growth accounts encompass an active approach that maintains unique client-level positions to deliver steady growth and downside protection. To maintain an up-to-the-minute macro view, the firm produces its Morning Notes daily.
March manufacturing and services PMI data suggests the boom in global growth has begun. Equities should have further upside for the next several months/quarters as we enter the early stages of a cyclical global recovery. We expect average equity multiples to stay near current levels and possibly expand until there is a negative macro development. The current question: Where should investors be positioned to maximize expected upside?
Let’s look at growth and value equities trends, where the broader bond market is, the current earnings season and finally…our current favorite value sector (Financials).
Let’s Talk About Growth
Growth stockstook a hit in mid-February when 10-year Treasury yields released through technical resistance at ~1.45%. As a result, the NASDAQ 100 (NDX) declined to technical support in the 12,200-12,400 range, before bouncing and accelerating as bond yields consolidated over the last two weeks.
The NDX is currently testing its February high at ~13,808. Expect a successful test with possible further upside to ~14,200, but keep in mind this counter-trend rally is closer to an end than a beginning.
But Don’t Forget About Value
Value remains the most attractive equity style with a median PE still 8.6 points below its historical spread to the average S&P 500 multiple. A boom in global growth should put upside pressure on bond yields and produce further curve steepening during Q2.
Speaking of Bonds…
- The recent stabilization in bond yields followed consistent Fed messaging on the timing of liftoff (not until 2024), which the market had pulled forward by several months.
- Near-term supply dynamics could pressure yields higher as the Treasury plans to issue ~$370B worth of bonds over the next three weeks.
- This Thursday’s release of US retail sales for March is another possible catalyst with near-term implications for yields and relative sector performance.
Bond yields may spend a little more time consolidating below the intraday cycle high of ~1.74%, but the time to start adding more cyclical/value and small cap exposure is now.
Consider the S&P 500 Value Index (SVX) started to underperform the broader S&P 500 (SPX) a full two weeks before 10-year yields hit ~1.74%, which means the corrective action associated with consolidating bond yields has already taken place. Any residual strength in growth vs. value over the coming days should be used to rotate away from growth into cyclical/value stocks.
The profit outlook going into CQ1 earnings season is highly supportive for the broad equity market. There has been some concern around last week’s higher PPI number, but the historical correlation between PPI and profits has always been positive.
Profit margins should improve as the acceleration in activity drives volumes and operating leverage. Consensus expectations for Q1 SPX earnings growth is running at 24.5%. However, expectations for Q1 cyclical sector earnings (that includes the 3 value sectors) are still 16% below pre-pandemic levels and offer the greatest upside.
Financials: Our Favorite Value Sector
Our favorite value sector is Financials, but US large cap banks likely had another fundamentally challenging earnings season during the first quarter. The first week of earnings season is always heavily skewed toward large cap bank results. Most large cap banks will deliver ‘low quality’ earnings upside in Q1 driven by loan loss reserve releases, investment banking and trading revenues.
Investors may ‘look across the valley’ with loan demand expected to pick up into H2 and Net Interest Margins (NIM) expected to gradually expand and flow into earnings by year-end.
Regional banks remain our preferred way to gain exposure to Financials. And while regional banks have had a strong start to the year (KRE up +28.97% vs. the SPX up +9.53%), the group still trades at only 1.3x Tangible Book Value vs. their historical average of 2x and pre-pandemic levels of 1.9x.
Expect Regional Banks to win market share from Large Cap banks and Fintech over the next 2-3 years. Why? They know how to loan money. Our favorite regional banks are FRC, SIVB, PNFP, SBNY and HBAN.
This market commentary comes from Jackson Square Capital’s Managing Partner & Portfolio Manager Andrew Graham.