Capital markets perspective: You can’t teach size

Capital markets perspective: You can’t teach size


College football fans know that size can make all the difference on the field.

In markets, size can make a big difference, too. First consider the difference between large-cap stocks and small. Large-cap U.S. stocks have rallied so far this year, with the S&P 500 Index up almost 13% since January 1. (The Nasdaq composite – home to a bigger allocation of stocks that are both big and growthy – are up more than twice that amount.)

It's hard to know for sure why larger stocks have been so dominant this year, and in some ways it’s simply a continuation of trends that have been in place since the COVID pandemic. But it’s also not entirely out-of-character for large stocks to outperform small when economic trends are as uncertain as they are today: All else equal, larger companies are sometimes thought to be better-positioned to endure economic recessions than smaller ones.

But the analogy goes beyond a preference for big market caps, too. For example, the National Federation of Independent Businesses’ small-business sentiment index has been depressed for nearly two years, with small business owners deeply pessimistic about the direction of economy, earnings trends, labor quality and a host of other things – most notably inflation – and the NFIB’s survey took another leg down last week when the September results were released.1 But larger firms, like those that answer PMI surveys for example, seem far less concerned: S&P Global’s most recent PMIs for both services sector2 and the manufacturing sector3 used phrases like “positive expectations regarding the outlook…” and “expectations for future output also rose … amid hopes of a pickup in demand conditions” when describing business leaders’ views about the future. Maybe the easiest way to reconcile these apparently disconnected results is by observing that PMI surveys generally pull from a much wider set of businesses – large and small –  while the NFIB’s captures only small operators. So even if the large players aren’t too worried yet, small ones have been concerned for almost two years.

And then there were the banks. As we wrote last week, last Friday represented the unofficial kick-off of third-quarter earnings season when a smattering of big banks released results. On the whole, earnings reports and the post-release conference calls were good, rife with examples of expanding interest margins, loan and deposit growth, lower-than-expected provisioning and charge-off activity, firming credit trends, and share buybacks.

Moving on… Did you notice how I didn’t even mention inflation until the last few paragraphs of the “what happened last week” section of this week’s Perspective? That’s because, as suspected, it looks like it will take a lot more than last month’s slightly hotter than expected CPI and PPI data to capture the market’s attention. For those keeping track, here are the details: Prices at the producer level came in at 0.5% month-over-month on rising energy and food prices. That was significantly higher than the 0.3% expected, and the upside surprise wasn’t entirely limited to volatile categories, either: Core PPI, which washes out food and energy, was also higher than economists had expected. Ditto for consumer prices, which were also a little hotter than hoped on both a core and headline basis – again, largely because of higher energy prices (although a widely expected adjustment in shelter prices clearly played a role on the consumer side, too).

For what it’s worth, markets hardly blinked: Wednesday, when the CPI data were released, ended up being the best day for U.S. stocks last week, while Tuesday – PPI day – was the second-best. Even if markets and the Fed are becoming less concerned about prices, inflation is still very much on the mind of consumers. In addition to the above-mentioned NFIB small business survey, where inflation remains small-business owners’ #1 concern alongside labor quality, inflation also loomed large in the University of Michigan’s mid-month consumer sentiment survey.4 According to the UofM, long-term inflation expectations surged 0.6% to 3.8%, the biggest increase since March and clearly counter to the trend of falling inflation expectations that has dominated the UofM data since the middle of 2022.

That matters for at least two reasons. First, consumer attitudes are heavily influenced by how they’re feeling about prices (particularly gasoline prices.) For evidence, you really don’t need to look much further than Friday’s release: Consumer sentiment – always the headline figure in the UofM’s release – dropped big, owing in large part to stress over inflation. But perhaps even more worrisome is how the Fed might react: If the Fed suspects that higher inflation expectations are becoming entrenched in consumers’ collective brains, the inflation-fighting equation will almost certainly change.  

One final read of inflation expectations released last week: The Atlanta Fed’s business inflation expectations survey showed that businesses weren’t quite as worried about inflation as the UofM suggests their customers might be. That survey, which polls businesses how they view inflation evolving over the next 12 months, has trended lower in much better-behaved fashion than the UofM’s consumer-focused survey and is now only a short hop from the Fed’s target of 2%.

For now, as the economy still struggles to decide whether it wants to accelerate or devolve into recession, bigger might still be better in a lot of ways. And as far as inflation itself is concerned, don’t mistake the market’s ambivalence for an all-clear.   

What to watch this week 

The biggest item on this week’s economic calendar will be retail sales release, due Wednesday. The data will reflect spending trends through the end of September and is therefore unlikely to include much impact from this month’s re-start of student loan payments just yet. It will, however, capture the turn in sentiment highlighted in last week’s UofM index as discussed above, and will also illustrate the continued drawdown of COVID-era excess savings, which researchers at the San Francisco Fed concluded should be almost entirely depleted by now. Looking forward, the extent to which these and other headwinds begin to impact consumer spending – particularly as the all-important holiday spending season gets underway – will say a lot about which direction the U.S. economy heads from here.

This week will also feature our first installment of housing data, starting with the National Association of Homebuilder’s builder confidence index on Tuesday, followed by starts/permits on Wednesday and existing home sales on Thursday. By now, trends in residential real estate are well-known: Transactions volumes are unlikely to pick up unless and until mortgage rates decline or prices relent.

On the industrial side of things, our first two regional Fed manufacturing reports arrive this week (Empire State on Monday and the Philly Fed on Thursday), as well as industrial production on Tuesday. Manufacturing has been contracting for the better part of a year, but recent data suggest the pace of that contraction has eased. If additional thawing becomes evident in releases like these, it could change the tone of the narrative materially.  

There are a few Fed-related things on the calendar this week as well, including a speech by Fed Chair Jerome Powell at the Economic Club of New York on Thursday and the Beige Book’s collection of regional anecdotes on Wednesday. You could also spend your time this week parsing the earnings releases of a few headliners due to publish results. Even though much of the market cap won’t report for at least a week or two, there are more than a few big, macro-relevant themes likely to be on display. The first of these is round two of last week’s big bank earnings, with companies like Goldman Sachs, Bank of America, Bank of New York, Morgan Stanley and US Bank all on tap for mid-week. Meanwhile, a steady drumbeat of small and regional lenders will continue, as well as a few non-bank financials. Last week’s bank earnings set a positive tone, but this week’s reports will help determine whether that was signal or noise.  

At least two of the "Magnificent Seven" stocks that have driven returns so substantially this year will also report this week, including Tesla and Netflix, both on Tuesday. Add to that a few semiconductor-related names with potential leverage to the much-hyped AI market, and this week could be one of the more interesting weeks during 3Q23 earnings season from a thematic standpoint.

For trends in the real economy, two rail operators (Union Pacific and CSX, both on Thursday) and a motor carrier (JBHunt, Tuesday) will report this week. Those who have been reading the Perspective for a while know that logistics and transportation firms are among those I believe most closely reflect the macroeconomic environment, and that remains even more true today as questions surrounding the health of the economy continue to mount. But of the three, trucker JBHT might be the most interesting. 

Finally, for a consumer view, look for several staples-related firms (Procter & Gamble on Wednesday and Philip Morris on Thursday) to provide good context surrounding the level of stress on the consumer as various headwinds build. As a contrast to the more stable topline profile of staples companies, the discretionary portion of consumer spending will be on display when numerous airlines (United, American and Alaska Air all report this week) alongside other leisure-related plays, like Las Vegas Sands. If the economy is truly slowing, it should begin to show up as a widening gap between the results – and more importantly, the outlook and guidance – provided by staples and discretionary firms during this and future earnings derbies. 

This material is neither an endorsement of any index or sector nor a solicitation to offer investment advice or sell products or services.

The S&P 500 Index and S&P MidCap 400 Index are registered trademarks of Standard & Poor’s Financial Services LLC. The S&P 500 Index is an unmanaged index considered indicative of the domestic large-cap equity market and is used as a proxy for the stock market in general. The S&P MidCap 400 Index is an unmanaged index considered indicative of the domestic mid-cap equity market.

Russell 2000® Index Measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 Index and it represents approximately 8% of the US market. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.


Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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