RBC Capital Markets Head of U.S. Equity Strategy Lori Calvasina joins Yahoo Finance Live to discuss the S&P 500's 2022 decline, big bank earnings, a recession, and the outlook for earnings moving forward.
BRAD SMITH: RBC Capital Markets is anticipating a modest gain for the S&P 500 this year, the investment bank putting its year-end price target for the index at 4,100. For more on the analysis behind this call, let's go and get to the RBC Head of US Equity Strategy, Lori Calvasina. Lori, always a pleasure to speak with you.
I believe this is our first time touching base in the new year. So happy new year to you.
LORI CALVASINA: I think so. Thanks for having me.
BRAD SMITH: Absolutely. And so help us walk through this target, 4,100 by the end of the year. Is it a straight line there? Is it kind of a lot of choppiness to get to that point? What is it from your point of view?
LORI CALVASINA: I think it's a-- think it's a choppiness. I think it's going to feel like a rough year. I expend-- I expect us to eke out a little bit of a gain. Maybe kind of a flattish-type year is how it's going to feel at the end of the day.
Look, I do think there's a chance that we have some decent volatility in the first quarter. And I know we've had a good start to the year. But we're sort of watching the banks react to earnings today. And it's a good reminder that the onset of tougher earnings and the onset of a tougher economy is something, I think, markets are going to have some trouble digesting.
Now, I'm not as bearish as some of my peers in the strategy community. I'm not arguing for 3,000 on the S&P. I think this is more of a retest, if that, of the October lows. But I think we've got some wood to chop here.
JULIE HYMAN: What do you think is going to be supportive? Why do you think things aren't going to be worse and aren't going to, say, retest the lows or go even lower?
LORI CALVASINA: So I think it goes back to what kind of recession do you ultimately expect us to have. And how does that get reflected in markets? So the October low we had was about a 25% drawdown. A typical recession is 27%.
You're going to get to even 3,200 on the S&P, that's pricing in more like a 32% decline. And remember, the pandemic was just 34%. So we think it's going to be that bad. I'm still not convinced of that.
The other thing is, we think earnings expectations, they are a headwind now. But markets, if you look at S&P pricing, typically find a bottom three to six months before earnings forecasts stop falling. Now, when do we think earnings forecasts are going to stop falling? Most years, we do tend to see that the cuts are done by April for the most part. So if you can kind of get most of the cuts done by March or April, timing-wise, that October low makes sense.
BRIAN SOZZI: Lori, within the sectors that you track from a company perspective, we had a JPMorgan calling out today. They're playing their business on a potential mild recession. Are there sectors that you see earnings estimates have already factored in a mild recession?
LORI CALVASINA: So I think that if you look at an area like semiconductors, we've seen the rate of upward revisions, basically late last year, plummeted to almost zero. And what we typically see there is, when you're that low, most of the cuts are in. And it's a good setup on a 12-month forward basis. I can contrast that with something like software, where we haven't seen the same degree of cuts.
So I worry a little bit more about software and services companies than semiconductor companies just in this reporting season because I think one of them, you probably had most of the cuts in. And the other, I feel like there's still, from a sentiment perspective at least, some earnings downgrades that need to happen.
The other area I worry about-- we're going through financials right now. It's been-- it's a sector we like this year. But it's been more resilient in terms of earnings expectations. So do some of these leaders, some of these areas of resiliency, like energy and financials, utilities, real estate, do they need to take their licks before we can get this downgrade cycle out of the way?
JULIE HYMAN: Right, because maybe the estimates haven't come down enough. One area that you have consistently liked for a while now has been small caps.
LORI CALVASINA: Yes.
JULIE HYMAN: We've been talking about it for a little while. I was just taking a look at the Russell 2000, which is down 13% or so over the past 52 weeks, not as big a drop as the S&P 500. Are we going to start to-- I mean, there's not a big gap though, in between the two. Are we going to start to see that gap grow?
LORI CALVASINA: I think so. And I was actually looking this morning at the year to date stats on the S&P versus the Russell 2000. And small caps are stealthily outperforming. I mean, I think we're up like 5%, 6% on the Russell and not quite as much on the S&P, closer to like 2%-3%.
So you're starting to see, like every little day that the small caps do a little bit better, it's adding up. And the small caps, they made their low in June, didn't make a new low in October, really have been outperforming since mid-May, with giving some of it back in December. But very quietly, they're emerging as this pocket of resilience.
And I think it's pretty clear that if you look at how they were trading over the summer versus large, they were baking in ISM manufacturing that had already plunged to like 39. So small caps just got this recession trade out of the way very, very early. And we've had this sloppy catch down in large cap that may not be completely done playing out yet.
JULIE HYMAN: Hmm.
BRIAN SOZZI: Lori Calvasina, RBC Capital Markets Head of US Equity Strategy, have a great weekend. Talk to you soon.