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U.S. small caps likely to outperform in 2023-BofA

Tue, 29th Nov 2022 18:56

Main U.S. indexes red, but DJI now near flat


Utilities weakest S&P 500 sector; energy leads gainers


Dollar ~flat; gold, crude, bitcoin gain


U.S. 10-Year Treasury yield rises to ~3.74%

Nov 29 - Welcome to the home for real-time coverage of markets brought to you by Reuters reporters. You can share your thoughts with us at


BofA Securities' head of U.S. small- and mid-cap strategy, Jill Carey Hall, said during the firm's year-ahead outlook Monday afternoon that small caps are likely to outperform large caps in 2023.

"We think any further downside would be more limited in small than in large caps, and once the market bottoms, this is usually the most bullish period for small," Hall explained.

"Even if we see more downside risk to equities, we'd still stick with small over large," Hall said during the outlook conference.

She says that small caps are even discounting a deep recession, and "relative valuations suggest a good opportunity to own small caps."

Small caps are more tied to services spending than goods spending, she noted. BofA expects consumer spending on goods to decrease in 2023.

"Small caps are much more exposed to services spending than goods spending," she said. "Typically in U.S. recessions, services spending holds up better. That didn't happen during COVID, when we all stayed at home and spent on goods... but typically services spending is more resilient."

Small-cap companies are also bigger beneficiaries of "capex cycles in the U.S."

Among small-cap sectors, Hall likes financials, energy and consumer staples. On the other hand, she says investors should be more cautious about investing in small-cap health care.


The CBOE volatility index registered closes in the 20.40/20.50 area last Wednesday and Friday, which were its lowest since mid-August's 19.53/20.20 levels.

The S&P 500 peaked on Aug. 16, after a more than 17% gain off its June low on a closing basis, but then plunged to its 2022 lows in mid-October.

After rallying about 13% on a closing basis off its October low, the SPX suffered a 1.5% pullback on Monday, and is off another 0.4% or so on Tuesday.

"This is exactly why we have had a 'lighten up when the VIX gets to 20' rule for much of the year," writes Nicholas Colas, co-founder of DataTrek Research.

The long run average for the CBOE VIX index (often called the market’s "fear gauge") is 20.

"Uncertainty around future economic and corporate earnings growth remains well above average. Therefore, when the VIX gets to 20 we know markets have gotten too optimistic. It is a simple rule, but it has served us well."

As much as Colas continues to believe in this indicator, he also wants to consider where it might be wrong about the near-term direction of U.S. large cap stocks.

According to Colas, Fed Chair Powell’s speech this Wednesday and the Dec. 14 FOMC meeting may support the view that the Fed is nearing the end of its rate tightening cycle.

He also sees a number of other supportive factors out there. Colas adds that December tends to be a decent month for U.S. equity returns, up 1.4% on average since 1928, and with a 73% win rate, which he says is the highest of any month.

Aside from tax loss selling, he thinks investors may be unwilling to give up hope for a year-end "Santa" rally after such a rough year for stocks.

Throw in lower oil prices, virtual currencies, a sign of investor risk tolerance, holding above their YTD lows, and stable 2-year Treasury yields, and the market may have a number of bullish tailwinds.

That said, Colas' takeaway is that the "safe, historically reliable call is to reduce equity exposure here," since the VIX, now just over 22, is still close to the 20 level.

"December could end up being an up month (as it so often is), but there may be better entry points as the VIX gets closer to 28 (1 standard deviation above its long-run mean)."


Two economic indicators sauntered through the door on Tuesday, the first in a busy, back-end loaded week which reaches its dazzling climax with the November employment report expected on Friday.

From now until then, market participants will be combing every data point for signs of economic softness, or evidence that Powell & Co's hawkish interest rate hikes could at least be moving the inflation mountain.

The mood of the consumer, on whose shoulder 70% of the U.S. economy rides, has dimmed a bit in November.

The Conference Board's (CB) consumer confidence index , landing amid the crucial holiday shopping stampede, shaved off 2 points to come in at 100.2, a hair above the 100 consensus.

Lynn Franco, CB' senior director of economic indicators, blamed the decline on a recent bump in gasoline prices.

"The Present Situation Index moderated further and continues to suggest the economy has lost momentum as the year winds down," Franco adds. "Consumers’ expectations regarding the short-term outlook remained gloomy."

"Indeed, the Expectations Index is below a reading of 80, which suggests the likelihood of a recession remains elevated."

Here's a look at the headline confidence number compared with front month gasoline futures:

Data geeks might find the yawning gap between "current conditions" and the more dire "expectations" component more than a little worrisome. It's a state of affairs that often acts as a harbinger of recession, as the graphic below helpfully illustrates:

Next, U.S. home price growth cooled a bit more than expected in September.

The S&P DJI Case-Shiller home price data showed monthly declines across the board in its 20-city composite. Year-over-year, the composite rose 10.4%, marking a steeper-than-expected cool-down from August's 13.1% reading.

It was the lowest annual increase since December 2020.

A demand boom and the resulting supply depletion has catapulted home prices into orbit. And mortgage rates have more than doubled this year, joining benchmark Treasury yields in their march up the mountain amid the Fed's policy tightening.

Together, the affordability of monthly home payments has evaporated for many potential buyers, particularly at the lower end of the market.

Applications for loans to purchase homes have plummeted by 43.9% in the last 12 months, according to data from the Mortgage Bankers Association.

"As the Federal Reserve continues to move interest rates higher, mortgage financing continues to be more expensive and housing becomes less affordable," writes Craig Lazzara, managing director at S&P DJI. "Given the continuing prospects for a challenging macroeconomic environment, home prices may well continue to weaken."

City-by-city, Miami and Tampa are still running hot, posting annual home price growth of 24.6% and 23.8%, respectively, while San Francisco - at 2.3% - was the coolest.

"Declines in house prices are especially pronounced in tech-centric metro areas and regions where affordability is most stretched, principally on the West Coast," notes Bill Adams, chief economist at Comerica Bank.

The main U.S. indexes are lower in late morning trade, with investors favoring value over growth.

Transports, banks, and small-caps are showing some strength.


Major U.S. stock indexes are edging up in early trading Tuesday, with Tesla and energy shares leading the way higher.

Energy led gains among S&P 500 sectors following a jump in oil prices, while utilities have the biggest decline early, but technology is also down.

Shares of Tesla are up more than 1% early.

Investors are still watching for news on public unrest in China and its impact on the country's COVID-19 restrictions.

Here is the early U.S. market snapshot:


The tech-heavy Nasdaq Composite Index hasn't had the best year, with the index falling 29% so far in 2022. But for cybersecurity firms, things could start looking brighter soon.

Wedbush notes that after robust earnings from Palo Alto , investor sentiment has seen a positive shift sector-wide, with deal pipelines, M&A potential and the massive shift to clouds still underway as the sectors heads into 2023.

Analysts at the brokerage said that while there is 'clear' uncertainty in a 'cloudy' macroeconomic situation, cybersecurity spending is gaining more of the 'budget dollars', with companies including Palo Alto, Zscaler Inc and Fortinet Inc having grabbed deals in a competitive environment.

Areas of identity threat detection, privileged access management (PAM), endpoint security all seem to be the hot cakes in the otherwise icy tech world, with key IT decision makers moving towards digital transformation and digital protection becoming the highest priority, according to the analysts.

Wedbush said that while Europe is seeing more deals slip away, the demand in the U.S is more than enough to offset the potential headwinds, with the brokerage anticipating the companies to get ahead of their targets in Q4 by 3%-4%.

The Global X Cybersecurity ETF, which contains some of the major cybersecurity companies, including Palo Alto, Checkpoint Software Technologies, Fortinet, Zscaler, and Tenable Holdings, has declined 27.7% year-to-date, slightly outperforming the tech-heavy Nasdaq.


On Monday, NYMEX crude oil futures hit a low of $73.60. With this, the futures fell to their lowest level since December of last year, and were down nearly 44% from their post-Russian invasion of Ukraine intraday spike high of $130.50 in early March.

Thus, they neared the level that President Joe Biden announced that the U.S. would look to replenish its Strategic Petroleum Reserve (SPR), buying back oil it sold for $100 at a price around $70.

Biden had drawn on the SPR in order to gain more stability in gas prices, although he said it was not a politically motivated move ahead of the U.S. November elections.

In any event, as reported on Nov. 23, U.S. crude oil stocks in the Strategic Petroleum Reserve hit their lowest level since March 1984.

Crude was pressured on Monday amid economic growth concerns exacerbated by strict COVID-19 curbs and protests in China, the world's biggest crude importer.

However, after hitting $73.60, crude reversed to the upside on talk of an OPEC+ production cut. On Tuesday, the futures are up nearly 2% at around $78.70.

Meanwhile, on Friday, crude futures closed at a level that was 1.18x the value of their 200-week moving average. With the bounce so far this week, the 200-week disparity is ticking up to 1.21x:

The disparity double-topped in early March and mid-June at 1.98x. Of note, since 1990, and prior to 2022, there were seven 200-WMA disparity peaks, 1.38x or higher. In six of those instances, crude ultimately retreated below its 200-WMA (sub-1.00 disparity). It was only subsequent to the 2005 peak, that crude bottomed in early 2007 at 1.04x the 200-week MA. Not quite 1.00, but pretty close.

Crude could, of course, mark time and churn, allowing the moving average to ultimately catch up (the 200-WMA is currently rising ~10-15 cents per week), or it could simply continue to rally.

That said, it now faces a number of nearby resistance hurdles including $81.65 and $87.25, ahead of the $93.75-$97.66 area.

It may remain an open question whether crude hits President Biden's buy level. However, traders remain focused on whether the 200-WMA, which now sits just shy of $65.00, will continue to work its magic as a powerful magnet.


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