RBC sees bigger gains for US equities as bulls fade

Investing.com -- Fading bullish sentiment could set the stage for stronger US equity returns in the months ahead, despite concerns over earnings revisions and contracting valuations, according to RBC Capital Markets.

In its recent report, RBC reveals that “modest downward revisions have returned to bottom-up consensus S&P 500 EPS forecasts as the new year has gotten underway,” coinciding with a stronger US dollar . This trend often pressures earnings estimates, which RBC identifies as a key headwind for equities in the near term.

Furthermore, positioning data from the Commodity Futures Trading Commission (CFTC) indicates that frothy sentiment among investors may have peaked. However, the American Association of Individual Investors (AAII) survey shows net bullishness waning, with the four-week average slipping to 6.45%—below the long-term average of 6.8% as of January 2.

“While this doesn’t tell us that the recent period of malaise in the stock market is over, we do think this deterioration in sentiment is actually good news for the stock market longer term,” RBC strategists including Lori Calvasina said in the report.

“Over time, 12-month forward returns in the S&P 500 from the current range of this indicator have averaged 10.6%. This is a slightly better return environment than the one this indicator was signaling back in early December (8.6%).”

According to RBC, earnings resilience continues to favor growth and mega-cap stocks. The firm points out that EPS revisions have been notably stronger in Growth stocks than Value, and the top 10 stocks by market cap compared to the rest of the S&P 500 index .

Elsewhere on the earnings front, one thing that jumps out is that EPS revisions trends have been much stronger in Growth than Value and the top 10 market cap names in the S&P 500 than the rest of the index, which helps explain the return of Growth and Mega Cap leadership in late 2024

Still, valuation concerns persist. RBC highlights that high forward price-to-earnings (P/E) ratios have started to contract.

Fund flows provide another layer of caution. Strategists report that “US equity funds flows deteriorated as 2024 came to an end,” with notable weakness in small caps. Momentum funds across developed markets also saw outflows.

Source: Investing.com