Topline
The stock market has minted a stunning rally amid hopes that the worst of the Federal Reserve’s interest rate hikes has passed and inflation has cooled, but Bank of America analysts on Tuesday warned prices remains too high and stocks still too expensive for the bear market to be over, at least according to one rule that’s held true perfectly in the past.
No bear market since at least 1935 has ever ended when inflation and stocks are as high as they are … [+]
Key Facts
In a Tuesday note to clients, Bank of America analyst Savita Subramanian said a sustained bull market remains “unlikely” even though the S&P 500 has surged more than 16% to 4,262 points since hitting a low this year on June 16, the day after Fed officials authorized the biggest interest rate hike in 28 years to combat decades-high inflation.
Subramanian and her team track a long list of indicators (Fed cutting rates, unemployment rising or markets rallying 5%) that help signal the start of a bull market, but so far just 30% of those items have been fulfilled; historically, 80% of the list is checked off before markets bottom out.
In particular, they write that no bear market since 1935 has ever ended when the consumer price index and S&P’s average price/earnings ratio add up to 20 or more—a phenomenon called the “Rule of 20” that signals stocks remain too expensive relative to their earnings and likely have further room to fall; with 8.5% inflation, the metric currently sits at 28.5.
In order to satisfy the rule and signal stocks may once again be due for a bull market rally, S&P 500 firms would have to beat earnings expectations by an average of 50%, Subramanian says—or in more extreme scenarios, the S&P would need to tumble more than 40% to 2,500 points, or inflation fall to 0%.
The bank’s research suggests the consumer staples and consumer discretionary sectors are most at risk in the current environment, though staples could hold up better as retail giants like Walmart and Target report that consumers increasingly shifting spending toward necessities like food and gas, as opposed to discretionary items like clothing and home furnishings.
The analysts aren’t alone in raising flags: On Monday, a team led by Morgan Stanley Wealth Management’s Lisa Shalett said it’s “not ready to say ‘all clear'” because recession indicators are still flashing and earnings expectations have not fallen enough to account for slower economic growth, adding “stocks are vulnerable to any data that doesn’t confirm the bullish narrative.”
Key Background
Major stock indexes plunged into bear market territory in June as investors awaited the Fed’s biggest interest rate hike since 1998, but stocks have since largely recovered on hopes that inflation has finally peaked. At one point down 23% this year, the S&P is now off just 11% since the start of January. However, the economy unexpectedly shrank for a second-consecutive quarter this year, and fears of a looming recession still haven’t subsided. Expectations for third-quarter economic growth have fallen, particularly due to worse-than-projected housing market data.
Chief Critic
“While recession risks remain high—odds are about even through 2023—the most likely outlook remains that the economy will avoid a downturn,” Moody’s Analytics chief economist Mark Zandi wrote in a weekend note. He notes the job market has remained resilient despite worries over the economy and points to recently declining inflation numbers as “especially encouraging.”
Further Reading
Dow Falls 200 Points, Stocks Lose Steam After Target Profits Plunge (Forbes)
Source: https://www.forbes.com/sites/jonathanponciano/2022/08/17/stock-market-crash-isnt-over-according-to-indicator-with-perfect-track-record/