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Q2 2024 Outlook: Rough Roads, Some Bulls

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In the first quarter (Q1) of 2024, the broad-market S&P 500 was up 10.56% in the Year Till Date (YTD). However, this cannot be construed as a sign that the entirety of the market has recovered. Given the variety of conflict and economic flashpoints around the world, various financial institutions contend that the outlook for Q2 2024 is quite nuanced.

Central to this nuance is the mistaken notion that rising tides raises all boats equally. The earnings sentiment of large companies – such as the constituents of the S&P 500 – substantially outpaces those of smaller companies such as the constituents of the Russell 20001. From the start of 2023 till the end of Q1 2024, the average Earnings Per Share of the S&P 500 has been stable while that of the Russell 2000 has been plunging.

Websim is the retail division of Intermonte, the primary intermediary of the Italian stock exchange for institutional investors. Leverage Shares often features in its speculative analysis based on macros/fundamentals. However, the information is published in Italian. To provide better information for our non-Italian investors, we bring to you a quick translation of the analysis they present to Italian retail investors. To ensure rapid delivery, text in the charts will not be translated. The views expressed here are of Websim. Leverage Shares in no way endorses these views. If you are unsure about the suitability of an investment, please seek financial advice. View the original at

One factor that helped float the inherent prospect within larger companies versus smaller companies has been the rates regime since the pandemic. A sharp rise in overnight interest rates allowed large companies to earn interest from their cash/working capital while the low rate environment that manifested in the immediate post-COVID period enabled large companies with strong credit ratings to refinance at lower rates. In contrast, smaller companies tend to not be rated for credit. Instead, they are more exposed to bank loans wherein the real cost of borrowing tend to be passed onto.

Rates staying high for longer imply that financing via loans are affected across the board. This has a direct impact on home buying. Among the various U.S. asset classes, the real estate sector shows the highest drawback from fair value estimations2.

When considered along factor styles and stock capitalization, the importance of size becomes even more prevalent. Overall, value factor stocks are lagging behind fair valuations while growth stocks are running ahead. However, this “overall” perception is heavily nuanced by size.

Among growth stocks, large- and mid-cap stocks are driving virtually the entirety of this valuation. Conversely, small-cap stocks show a very pronounced lag behind fair value estimations among value stocks. Large-cap stocks are the highest-priced across all factor styles while small-cap stocks are the most beleaguered.

As of February 2024, the US equity market had hit valuation levels not seen since the dot-com and 2021 technology bubbles3. This is best represented by estimating the Z-score of US equities, wherein the equities’ variability in returns is measured against their mean values. Since 2023, this measure has been seen to be steadily climbing.

Historically, the current equity valuation has led to low equity returns after subtracting inflation over the subsequent 10 years. Adding to the downward pressure is the fact that rates will stay “higher for longer”: as of Friday, the yield on the 10-Year Treasury had moved up to 4.62% as of Friday’s close with some institutions expecting the rates to go over 5% in the course of the year.

Views on Q2

Overall, institutions show a significant amount of convergence on views. Prominent points of consensus was exemplified by Saxo Bank’s commentary in March this year wherein U.S. equities have broadly slipped into a neutral outlook while China’s preponderance in Emerging Markets creates a negative outlook for stocks in this category.

European equities, on the other hand, appear positive in many outlook summaries. This is largely on account of three factors:

  1. Through most of the Eurozone as well as the United Kingdom, overall disinflationary trends are manifesting with some strength after factoring out higher costs due to energy consumption. In fact, energy stocks are overall poised to be relatively strong performers, given that OPEC+ have been largely neutral on increasing production until at least July4.

  2. Given the aforementioned disinflationary trends, most members of the European Central Bank signalled last week that they’re willing to perform at least one rate cut in June5. This would serve to provide some degree of amelioration to the loans and mortgages markets while also incentivizing capital flows back into equities.

  3. The ongoing conflict flashpoints in both Ukraine as well as in the Middle East have been propelling European governments to increase focus on bolstering defence spending, with particular focus on indigenous efforts.

However, it remains a fact that, as with the U.S. equity markets, market breadth is under significant stress. In addition to defence stocks, the most significant sectors of interest are pharmaceuticals and tech – notably those with significant AI footprint.

However, while AI is likely to remain a central theme for some time to come, there are largely unresolved questions on exactly how high can AI-relevant stocks be valued at given an upper ceiling on the maximum extent of cost benefits to the users of said technology. This past Friday in particular highlights the market’s nervousness over AI’s overvaluation: after Super Micro Computer (SMCI) declined to publish preliminary Q1 results, the stock dropped 23% in a single day. Panic rapidly spread to other stocks of more seasoned high-performers: NVIDIA (NVDA) fell 10% on the same day, Advanced Micro Devices, Inc. (AMD) dropped by 5% while Arm Holdings plc (ARM) lost nearly 17%.

Along with top-line European equities, the energy and financial sector also hold significant bullish potential. However, overvaluation concerns will likely make resistance a recurring feature. All in all, Q2 is likely to be a rocky ride. Professional investors will likely find a vast number of tactical opportunities in the markets over the current quarter. Leverage Shares has a number of promising products in either direction that seasoned players across Europe are bound to find interesting: click here to browse the products currently on offer.


Footnotes:

  1. « Q2 2024 Equity Market Outlook: Three charts on equity markets », UBS, 12 April 2024
  2. « Q2 Stock Market Outlook: Contrarian Plays Look Increasingly Attractive », Morningstar, 29 March 2024
  3. « Equities: The AI and obesity rally is defying gravity », Saxo Bank, 3 April 2024
  4. « OPEC+ defers tricky decision on production increases », Financial Times, 5 March 2024
  5. « Here’s what 12 European Central Bank members said about interest rates this week », CNBC, 19 April 2024

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