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Portfolio > Economy & Markets

Never-Ending Stock Market Churn Keeps Pushing Bottom Targets Lower

By Lu Wang

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What You Need to Know

  • The specter of a recession has driven traders to pare back their expectations on Fed hikes, leading to a drop in Treasury yields.
  • The pessimists have history on their side.
  • Strategas Securities looked at data from nine decades and found virtually no reason to believe the current market rout is over.

Week after week of on-the-fly calculations about the intensity of inflation and the likelihood of a recession are preventing markets from finding equilibrium. The churn is spurring increasingly worse forecasts for when and where the volatility will cease.

Turbulence remained the rule Tuesday. After sinking more than 2% earlier in the session, the S&P 500 erased its decline to eke out a small gain. It’s the fourth time in 2022 that the index reversed an intraday drop of that magnitude, more than in any year since 2009.

Speculative technology shares led the rebound, with the ARK Innovation ETF (ticker ARKK) rallying over 9%, as traders sought bargains in the beaten-down sector and lower yields eased pressure on companies that have yet to make profits.

The reversal occurred even as the drumbeat of bearish calls grew louder. In a survey by Deutsche Bank AG conducted last week, 72% of respondents expected the S&P 500 to fall to 3,300 first, rather than rallying to 4,500.

The gauge closed at 3,831.39 on Tuesday. Jonathan Golub at Credit Suisse Group AG just became the latest Wall Street strategist to downgrade his market outlook.

The pessimists have history on their side. Strategas Securities compared market and economic indicators now versus past bear cycles over nine decades and found virtually no reason to believe the rout is over.

“After examining the data, it would be difficult to claim with confidence that we have yet reached a bear-market bottom,” the firm’s strategists including Jason Trennert wrote in a note.

A Bloomberg chart dated July 5, 2022 and entitled Anatomy of Bear Market Bottom showsthat an equity trough in June 2022 looks different from other major ones in the past.

U.S. stocks have lost as much as $15 trillion in value from their recent peak, with the Federal Reserve embarking on its most-aggressive tightening campaign in decades to rein in red-hot inflation.

Rising borrowing costs have prompted investors to reassess equities, leading to one of the fastest valuation contractions in history.

The devaluation process for the S&P 500 is a development that Golub at Credit Suisse acknowledged when trimming his year-end target to 4,300 from 4,900. Still, he predicts the market to recover in the second half as the economy avoids a recession.

Others are less sanguine. In the poll by Deutsche Bank, 90% of respondents anticipated a recession by the end of 2023 and 20% saw one happening this year. That’s up from 37% and 2%, respectively, in January.

The specter of a recession has driven traders to pare back their expectations on Fed hikes, leading to a drop in Treasury yields.

Technology shares, home to the bear market’s largest casualties, climbed Tuesday as the retreat in bond rates eased some pressure for the richly valued industry. The tech-heavy Nasdaq 100 jumped 1.7% after falling in 11 of the last 13 weeks.

To Esty Dwek, chief investment officer at Flowbank, it’s too early to call all clear.

“Market sentiment is fragile and recession fears are mounting,” said Dwek. “It does not feel like we are at the bottom yet, so it’s still a trader’s market and we are not buying.”

A Bloomberg chart showing that the S&P 500 P/E now sits above where it was at end of all previous bear cycles, as of July 5, 2022.

In the past, a sustained market recovery tended to happen when valuations are depressed, and clear evidence exists of an economic slowdown. Right now, the opposite is largely on display, going by the model developed by Strategas.

Inflation, a target of the Fed’s raging tightening campaign, stood at a four-decade high of 8.6% in May, compared with an average of 3.5%. On the other hand, the labor market is robust, with the 3.6% jobless rate hovering near multi-decade lows. During past bear-market bottoms, unemployment averaged 5.8%.

Meanwhile, credit spreads on corporate bonds are subdued, a sign of relatively easy financial conditions. The premium demanded on junk debt is 569 basis points, roughly half the average seen at the end of last three cycles, Strategas data show.

At the low in June, the S&P 500 was trading at 18 times earnings, a multiple that exceeded trough valuations seen in all previous 13 bear cycles. Put another way, should stocks recover from here, stocks at this bear-market bottom will have been the most expensive on record.

Calling a floor here requires a firm belief that stocks either deserve a higher premium than usual or that earnings will keep growing into the stretched valuations. To Marcus Morris-Eyton, a portfolio manager at Allianz Global Investors, that’s a lot to ask.

“The market’s focus has shifted from worrying about inflation to concerns surrounding the extent of the likely upcoming economic slowdown, at a time when central banks are withdrawing liquidity,” said Morris-Eyton.

“While valuations have fallen across the board this year, we have yet to see material earnings downgrades, with many fearing that declining earnings will provide the next leg down for equity markets,” he said.

(Image: Shutterstock)

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