Is the US stock market headed for new lows?



Stock markets have taken heavy damage this year, suffering at the hands of rapidly rising interest rates. Valuations have compressed but are still not cheap enough to lure in bargain hunters, and there is a clear risk that earnings estimates are revised lower as the data pulse slows, especially in Europe and China. While this could spell more trouble for equities, investors should not lose sight of the big picture - every crisis passes. 

Fed hangover

For more than a decade after the financial crisis, central banks and equity markets were best friends. It was a period of very low inflation, so every time the economy faced some problem, investors could count on central banks to ride to the rescue by lowering interest rates or doing quantitative easing. 

This recipe is rocket fuel for stocks. In a regime of low or negative interest rates, returns on bonds are miniscule, which naturally pushes investors towards riskier assets. With money managers raising their exposure to stocks and companies enjoying easier access to capital, valuations usually expand and markets thrive. 

Enter inflation. An overload of public spending during the pandemic coupled with supply chain disruptions and the Ukraine war came together to generate the greatest inflation shock in four decades. Central banks spearheaded by the Federal Reserve decided they had to extinguish this firestorm at all costs, so they started raising rates at an incredible pace. 

Policymakers hope that higher rates will lead to an economic slowdown, initially in sectors such as housing that are more sensitive to higher borrowing costs and ultimately in the broader economy. Once unemployment begins to rise, that will hopefully reduce demand enough to cool inflation. In other words, the plan is to engineer a recession in order to fight inflation. 

Still not cheap

Over time, rising interest rates translate into lower valuations for riskier assets as traders dial back excessive risk-taking in favor of safer plays. This is precisely what happened this time - most of the selloff in stock markets boiled down to a compression in valuation multiples. 

Since the beginning of the year, the S&P 500 index has lost 21% of its value. Over the same timeframe, its valuation from a price-to-earnings perspective has declined by around 25%. Despite this massive correction though, the market is still not cheap from a historical perspective. 

The price-to-earnings multiple denotes the dollar amount someone would need to invest to receive back one dollar in annual earnings. As such, the lower this number is, the ‘cheaper’ the market is considered. The S&P is still trading at a forward multiple of 16.8x, while most of the selloffs over the last decade - for instance in 2020, 2018, 2016, and 2015 - ended with a multiple closer to 14x or 15x earnings. 

In fact, that may be too optimistic since the last decade was characterized by ultra-low interest rates, and therefore elevated valuation multiples. With rates much higher now and the Fed’s quantitative tightening process doubling in speed this month, this bear market might conclude with an even lower valuation multiple, leaving ample scope for further downside.

Even more so if earnings estimates are revised lower. The Fed is actively trying to weaken the US economy and the bond market is screaming it will get its wish, with the yield curve inversion deepening lately. That’s bond traders betting on the economy going downhill, and it has preceded recessions with terrifying accuracy. 

Additionally, consider what is happening around the world. Companies in the S&P 500 receive some 40% of their revenue from overseas, increasing to almost 60% in the tech sector. Those revenues will come under pressure from two sources - a stronger US dollar and the twin crises tormenting Europe and China. 

Winter in Europe could be harsh considering the dramatic spike in energy prices. Authorities have rolled out several measures to spread the burden, but the consumer will still take a heavy hit. The situation in China is even worse, with the property sector melting down and strict covid lockdowns in major cities - a combination that has brought the economy to its knees. 

Don’t panic

All told, there’s likely some more downside left for equities, especially in case a recession does materialize. There is a long lag between raising interest rates and the time it impacts economic activity, so the real effects of the forceful tightening today might only show up next year. 

Business surveys and other leading economic indicators already paint a grim picture of what comes next and the charts concur, with the S&P 500 trading below a downtrend line and its key moving averages. If it does break to new lows, a fierce battle could take place around 3,500, which is the 50% retracement of the rally from covid lows to record highs. 

Beyond that, the focus would turn towards the 3,200 region, some 15% lower from current levels. This is where the risk-to-reward profile would become much more favorable, as that region would be consistent with a valuation of around 14x forward earnings. 

The good news? Even if there is a recession, it is likely to be shallow since it will be caused by the Fed itself, not some external shock. Once the economy is in real trouble, the Fed can turn the ship around, assuming the inflation problem is cured by then. 

Don’t miss the forest for the trees - every crisis passes and markets move higher over the years. This storm might simply offer patient investors better entry points. 

Pinakabagong Balita

Technical Analysis – Netflix stock rangebound after completing golden cross



Stocks gain on dovish FOMC minutes, year-end rally in focus – Stock Market News


Technical Analysis – Apple stock in tight range after advance pauses


Disclaimer: Ang mga kabilang sa XM Group ay nagbibigay lang ng serbisyo sa pagpapatupad at pag-access sa aming Online Trading Facility, kung saan pinapahintulutan nito ang pagtingin at/o paggamit sa nilalaman na makikita sa website o sa pamamagitan nito, at walang layuning palitan o palawigin ito, at hindi din ito papalitan o papalawigin. Ang naturang pag-access at paggamit ay palaging alinsunod sa: (i) Mga Tuntunin at Kundisyon; (ii) Mga Babala sa Risk; at (iii) Kabuuang Disclaimer. Kaya naman ang naturang nilalaman ay ituturing na pangkalahatang impormasyon lamang. Mangyaring isaalang-alang na ang mga nilalaman ng aming Online Trading Facility ay hindi paglikom, o alok, para magsagawa ng anumang transaksyon sa mga pinansyal na market. Ang pag-trade sa alinmang pinansyal na market ay nagtataglay ng mataas na lebel ng risk sa iyong kapital.

Lahat ng materyales na nakalathala sa aming Online Trading Facility ay nakalaan para sa layuning edukasyonal/pang-impormasyon lamang at hindi naglalaman – at hindi dapat ituring bilang naglalaman – ng payo at rekomendasyon na pangpinansyal, tungkol sa buwis sa pag-i-invest, o pang-trade, o tala ng aming presyo sa pag-trade, o alok para sa, o paglikom ng, transaksyon sa alinmang pinansyal na instrument o hindi ginustong pinansyal na promosyon.

Sa anumang nilalaman na galing sa ikatlong partido, pati na ang mga nilalaman na inihanda ng XM, ang mga naturang opinyon, balita, pananaliksik, pag-analisa, presyo, ibang impormasyon o link sa ibang mga site na makikita sa website na ito ay ibibigay tulad ng nandoon, bilang pangkalahatang komentaryo sa market at hindi ito nagtataglay ng payo sa pag-i-invest. Kung ang alinmang nilalaman nito ay itinuring bilang pananaliksik sa pag-i-invest, kailangan mong isaalang-alang at tanggapin na hindi ito inilaan at inihanda alinsunod sa mga legal na pangangailangan na idinisenyo para maisulong ang pagsasarili ng pananaliksik sa pag-i-invest, at dahil dito ituturing ito na komunikasyon sa marketing sa ilalim ng mga kaugnay na batas at regulasyon. Mangyaring siguruhin na nabasa at naintindihan mo ang aming Notipikasyon sa Hindi Independyenteng Pananaliksik sa Pag-i-invest at Babala sa Risk na may kinalaman sa impormasyong nakalagay sa itaas, na maa-access dito.

Gumagamit kami ng cookies para mabigyan ka ng mahusay na karanasan sa aming website. Magbasa pa o palitan ang iyong cookie settings.

Babala sa Risk: Maaaring malugi ang iyong kapital. Maaaring hindi nababagay sa lahat ang mga produktong naka-leverage. Mangyaring isaalang-alang ang aming Pahayag sa Risk.