Closer To The End Than The Beginning?
To be sure, it's a very busy time for anyone managing money in the markets. As such, I'm going to provide an executive summary of what I see happening at this time.
Summary
Stock market officially in "growth scare" mode. Worries about recession and EPS estimate revisions surging – leading to "risk off" environment.
Market Drivers: Last week, earnings reports from WMT, TGT, ROST brought profit margin compression (resulting from inflation, labor costs and supply chain issues) and struggling consumer narratives to the fore. This week brings another earnings-based fear as SNAP warned about the macro environment for online advertising "has deteriorated" faster than expected (vs only a month ago). This adds to multiple contraction/valuation and growth themes that have plagued trading. Market appears to be in process of pricing in lower earnings expectations (consensus estimate levels) and recession potential. Macro concerns being reinforced by this week's dive in bond yields.
Positives: Fed's reluctance for 75 bp rate hikes, the pullback in rates, peak inflation and peak hawkishness themes, overall strong consumer (although low end being impacted by inflation) and corporate balance sheets, pickup in buyback activity, and China policy support. Also supportive: oversold conditions, extreme negative sentiment (highest put/call ratio since March 2020), upcoming quarterly rebalancing adjustments, and "time for a bounce/calling bottom" narratives.
Negatives: Bear market narrative continues to evolve on back of Fed-led global monetary shift. Last week's focus was on inflation pressures on profit margins, which led to concerns about 2022 consensus earnings estimates. This week it's about systemic risk potential (Bitcoin?) and macro backdrop deterioration (online advertising and recession). Additional concerns include lack of "Fed put," growth/valuation narrative, stagflation fears, China lockdown headwinds, pickup in equity outflows, and earnings misses.
Where We Are Now:
Some interesting stats from Wall Street analysts worth noting...
Deutsche Bank: This is 6th largest non-recession correction in post-WWII era. Including recessions, average decline is -23.9%. Projects low of 3650 (-6.4% from 5.20.22 close).
Ned Davis Research: Mean decline for cyclical bear markets w/in secular bull is -22.8% (3703 or -5%). Mean for all bears -30.8 (3319 or -15%)
Credit Suisse: 6th time since 1978 S&P has fallen at least 19% but did not enter bear market territory. The following 12 months = big gains in 5/6 of the years. October 1998 & December 2018: +37%, October 1990: 29.1%, October 2011: 32%. But: 3 times Fed easing was catalyst for rebound.
Quick Valuation Checks:
Refinitiv: S&P 500 forward (12-month) PE: 16.4 v 22 on 12.31.21. Below the 5-year average of 18.6 and the 10-year average of 16.9.
NDR: PE multiples have compressed more in this cycle than the average bear market.
Truist: Over last 90 days, S&P 500 seen sharpest contraction in forward P/E in past 15 year. 90-day contraction at level below Covid Crash and 2008.
Summary:
It appears we are dealing with a severe correction/cyclical bear market being driven by the fear of what could happen based on Fed actions and inflation. For me, the bottom line is we are likely closer to end than beginning.
Now let's review the "state of the market" through the lens of our market models...
The Big-Picture Market Models
We start with six of our favorite long-term market models. These models are designed to help determine the "state" of the overall market.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR.
The Fundamental Backdrop
Next, we review the market's fundamental factors including interest rates, the economy, earnings, inflation, and valuations.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR.
The State of the Trend
After reviewing the big-picture models and the fundamental backdrop, I like to look at the state of the current trend. This board of indicators is designed to tell us about the overall technical health of the market's trend.
The State of Internal Momentum
Next, we analyze the momentum indicators/models to determine if there is any "oomph" behind the current move.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR.
Early Warning Indicators
Finally, we look at our early warning indicators to gauge the potential for countertrend moves. This batch of indicators is designed to suggest when the table is set for the trend to "go the other way."
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR.
Thought for the Day:
Smooth seas do not make skillful sailors. -African Proverb
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor
Disclosures
At the time of publication, Mr. Moenning held long positions in the following securities mentioned: TGT - Note that positions may change at any time.
NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES