Fast Moves in Rates ‘Freak People Out,’ RBC’s Calvasina Says
(Bloomberg) -- Up 1% one day, down an equal amount the next, the market’s been serving up a bout of volatility traders haven’t seen all year. There’s plenty to worry about and, by many measures, pessimism among investors is growing.
Lori Calvasina, managing director and head of U.S. equity strategy at RBC Capital Markets, joined the “What Goes Up” podcast to talk about the mood of the market, why the debt-ceiling reaction was surprising to her and why small-cap stocks can do well going forward.
Below is a lightly edited transcript of the interview highlights. Click here to listen to the full podcast, and subscribe on Apple Podcasts, Spotify or wherever you listen.
Q: You’ve spent a lot of time looking at investor sentiment and it had really soured in September. And it’s always hard to quantify and dissect what’s causing it, but we have seen this strong market reaction to Congress postponing the day of reckoning for the debt ceiling issue. Did that surprise you?
A: The conventional wisdom is this issue comes up every few years, they always figure out a way to avoid financial Armageddon and get it done. I was out talking to clients this week about this issue and the response is ‘Well, they always get it done, I’ve learned to ignore this issue, there’s a lot of noise.’ And then lo and behold, we see this enormous reaction in markets. So I think it probably was a little bit different this time, just because it just wasn’t clear how they were going to get to resolution. It did seem like there was a little bit more than theater this time around. So maybe that worry was a little bit deeper than a lot of us were letting on.
Q: What else is behind the two-way volatility that we’ve seen from markets and what does it all mean for investors?
A: Over the past couple of weeks, the jarring move that we had in the 10-year Treasury yield was something we certainly heard about from a lot of investors. When you get into these discussions with people, it’s never the direction or the magnitude of the move, it’s the speed of the move that tends to freak people out. I think we did have a very quick move here. We did an investor survey at the end of September and we give people a write-in question and we ask, what keeps you up at night? And we had one person write in: ‘a rapid rotation from growth back to value, which we’re not positioned for.’ So I think it’s not just what’s happening on the macro variable -- it’s the fact that it happened quickly and people weren’t set up for it. And you saw a fierce rotation out of technology stocks, which have been the long-term favorites of a lot of investors. And I think people knew in the back of their heads rates might go up, we think financials are going to catch a bid. But the fact that it happened so quickly, that everybody’s favorite stocks in the tech sector flipped so quickly, I think it was a combination of all of that.
Q: Are we poised for some more value outperformance going forward?
A: I think so. We’re stopping the conversation in terms of, we like value, we liked growth. We’re trying to say, just have exposure to both. We think it’s going to be a very choppy leadership environment over, say, the next year, year and a half. So that’s how we’ve positioned everything. But the really interesting conversation is why and the different time-frames we see. So really since early August we’ve changed all those positioning calls and the framework we tried to lay out was -- at the time, at least -- we said, look, there have been some very clear pressures on the value trade that have caused people to shift back into growth. And at the time, it was the Delta variant, some of the supply-chain pressures. A lot of it was Covid, to be honest -- there was still a lot of uncertainty there. But we said, look, we’re going to come out of this. We think Wall Street has not really properly baked in a lot of the things we went through at the end of the summer, but we’re going to come out of that. And when we come out of that, we think you’ll see another big intermediate-term pop in the value trade. And we said we think it ends some time mid-to-late next year, so there’s an expiration date on that trade. And we think growth leadership will eventually take over again late next year.
Q: How are you thinking about small caps going forward given all these catalysts that potentially could help them out?
A: With small caps, and people hate it when I say this, but I really don’t think earnings matter that much. The reality is that small caps have so many companies with losses -- and it’s obviously more now than in the past. But the reality is there’s really no good way to calculate the EPS growth of the Russell 2000. I just realized over time, that’s just not what the stocks trade on -- the stocks tend to trade on higher-level macro variables. And the only way that earnings seeps in is when you look at it from a quality perspective and people want higher quality. So then the sheer number of companies with losses will push people out of that space into bigger caps. That’s certainly something that hurt small caps over the summer -- the nervousness around the Covid outlook, the Fed, a lot of other things pushed investors back toward higher quality stories, and that pulled some of the multi-asset investors out of small cap. But that’s really the only time you really want to pay too much attention to earnings...Small caps and value are not always the same trade. I think they are the same trade right now. If you look at how large has performed versus small, and growth has performed versus large within the Russell 1000, both of those trades have been moving in tandem with the rate of change in Covid cases in the U.S. That’s been true for small caps since last November. It’s been true for value, growth since March. They are also both very sensitive to interest-rate direction. And this is something we’ve seen over time that when the 10-year yield is going up -- it doesn’t really matter why it’s going up -- small caps tend to outperform and value tends to outperform. Right now financials is a huge influence on both the small-cap space as an asset class and the value trade.
Q: You have a new survey out titled “The Mood of the Market Has Gotten More Pessimistic, But Investors Are Still Buying Value.” Can you walk us through your findings?
A: The overall mood of the market was just not as chipper as it was earlier in the year. We’ve seen that progressing over the last couple of surveys. But investors still seem to be on board with this value trade, and specifically the financials and energy, which I think makes sense. Those areas are not at the epicenter of supply-chain concerns. And going back to the topic of taxes -- when you talk to people about the case for a pullback in markets late in the year, and we’ve been in that camp as well, I find a lot of people are pointing to this idea of corporate taxes and that it’s not been baked in and it’s going to be this big disaster for corporate America longer-term. And we asked the investors in the survey, we said, ‘What do you think this does to earnings? What do you think this does to performance?’ And we found that on the question of corporate taxes, most people were in that camp saying, yeah, it’s going to be a 1-5% hit to performance. It’s going to be a 1-5% hit to earnings...We asked some questions on supply chains, which has been the big freak-out point post-Labor Day for a lot of investors. And we’ve just been hearing a lot of negative commentary around that. But we found a general vibe. Most people are, I would say, more worried about second half 2021 numbers as opposed to 2022 numbers. But when we asked people, how worried are you about this? Most people picked the, ‘I’m worried, but I’m not panicked. I think we’ll get some downward revisions and misses, but it’s not the end of the world.’ And it just goes to show me that people are taking some of these concerns in stride.
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