Stocks dropped during the holiday-shortened week as economic data remained firm, prominent corporate executives gave warnings on the economy, and the jobs report implied the Fed will remain hawkish. The S&P 500 fell 1.20% last week and is down 13.80% year to date.
Not as Bad as Feared, But How Much Better Are Fundamentals?
Stocks dropped last week, not because anything bad happened, but because markets needed to digest the near 10% rally from the May 20 lows. Since those lows near 3,800 in the S&P 500, there has been real progress: China is reopening, and hopefully the economy will be close to operating at near full capacity within a month. That will add a large tailwind to the global economy and perhaps most importantly, ease supply chain stress (which will help pressure inflation).
Meanwhile, after seven straight months of Fed officials consistently upping hawkish expectations and rate hikes this year, the last several weeks have seen Fed officials dial back the incrementally hawkish rhetoric. Practically, that’s led markets to begin to believe the Fed may “pause” rate hikes later in the fall after we get the two 50-bps rate hikes in June/July and another hike in September.
But that incremental improvement now has been priced in from a valuation standpoint. At this point, investors will begin to value the market via expected 2022 earnings, and the consensus is currently $249. But we don’t think there’s anyone on the Street that thinks those numbers won’t decline. We’ve been operating on an assumed $240 S&P 500 EPS estimate, and based on that number, the market is trading at a multiple of 17.1. That’s not an expensive multiple, but it’s not compelling enough to invite materially more buying given no one knows the depths of the coming economic slowdown.
What’s it all mean?
We need more actual good news for stocks to move higher from here (above 4,200 towards 4,300 in the S&P 500). That may sound simplistic, but it appears the quasi-panic we saw that pushed the S&P 500 to 3,800 has passed, and investors are taking a more balanced view (not everything is horrible, and there is a path towards continued gains as we’ve laid out in our “Keys to the Bottom.”
However, at these levels and these valuations, we need to see more proof those “Keys to the Bottom” are becoming more likely for stocks to move materially higher from here. That means more reopening in China (and not going backward) and more proof that inflation has peaked (Friday’s CPI will be significant) and that the Fed has reached peak hawkishness.
From a tactical standpoint, the outlook remains mixed at best. We can’t confidently say the bottom is absolutely “in,” so again, we’d view this rally as an opportunity to “right-size” volatility in portfolios via rotating out of growth and high-beta names to lower-volatility value ETFs and also high-dividend ETFs because, at minimum, volatility will remain elevated. And while the outlook has improved compared to the last several weeks, it’s entirely possible this is just a bear market rally, and we want to make sure everyone can sleep at night if we revisit those lows near 3,800.
