Market Strategy 10/17/2022
It’s Not Going to Take a Miracle…
It will take considerable effort to address the issues at hand holding markets hostage
Key Takeaways
- Q3 earnings season got under way last week when the big banks began to report on Friday. With only 35 or 7% of the firms in the S&P 500 index having reported, so far earnings are off 3.5% from a year ago despite revenue growth of 9.5% (also YoY).
- For a second week in a row a powerful rally was offset by sizeable declines in the days that followed.
- Bonds sold off last week sending the 10-year Treasury yield closing over 4% on Friday, up 251 basis points in 2022.
- The US dollar continued to appreciate last week, and is up 15% from the start of the year.
- Consumer price data out last week pointed to the persistence of inflation as prices in September were up 8.2% from a year ago
We are updating our year-end price target for the S&P 500 in light of the 24.8% downdraft the index has suffered from the start of the year.
- Based on the index’s closing level of 3583 last Friday we now see just under 12% potential upside in the index by year-end to establish a target of 4000.
- Our reduced price target is based on our earnings projection of $230 per share for the S&P 500, which is unchanged from our previous forecast and which, coupled with our revised target, implies a P/E multiple of 17.4x.
- We believe US economic fundamentals remain remarkably resilient though challenged in a highly transitional environment by persistent high levels of inflation, increasingly restrictive monetary policy to address the inflation, and supply chain problems that remain as well.
- While job growth and consumer spending continue to show relative strength, the economy overall is showing signs of slowing as a result of rising interest rates.
- Sentiment among market participants remains decidedly negative and an impediment to the sustainability of powerful rallies which have occurred in the equity market as recently as last week and over the summer (from mid-June to mid-August).
- Our view remains bullish on equities as the stocks of many solid companies look grossly oversold as a result of extreme negativity that is evidenced in polls of investment professionals and private investors and in the day to day volatility in the markets.
- Our year-end target price reduction for the S&P 500 is simply a function of the few weeks left in the year to effect a massive rally short of a miracle based on the levels of uncertainty the market has to digest at this time.
- In our view the rallies that ran earlier this year have shown where the market wants to go once the Federal Reserve's efforts to curb inflation have shown some positive effect in actually curbing inflation. Last week's CPI, core CPI (ex: food and energy) as well as the PPI numbers and the jump in the 30-year mortgage rate simply didn't do that.
- The level of negative projection driving current market sentiment reminds us of similar periods over the course of our nearly four decades in the market when negativity came easily in response to challenges to the economy and the markets that raised high levels of concern and extreme market reactions.
- We have found over the course of our tenure in the markets that so long as monetary policy makers, government officials, business leaders and the consumer respectively address the problems at hand to work towards averting or resolving a crisis, history has shown that the issues of the day often in hindsight have proven not only to be navigable but in fact have often presented opportunities that result in future prosperity and growth.
- Diversification, patience and an eye for "babies that get thrown out with the bath water" have over the course of market history been shown to benefit investors who manage to "keep their cool" when others seemingly "lose their heads".
- For now the Fed's intention appears clear to us. The end of "free money" is at hand and it is causing deleveraging that has likely caused a high degree of consternation among some market participants.
- The bad news and the good news is that the Fed appears to be sticking to its plan of bringing inflation under control. We do not expect the Fed to pivot before its efforts to stem inflation have shown more than just a little effect.
- Free money has led to speculation in a myriad of cyber currencies, meme stock volatility and even swollen valuations among core assets including stocks, commodities, real estate and established currencies. The Fed waited long enough to take the proverbial punch bowl away to abandon its efforts now.
- The process of unwinding leverage tends to always be painful whenever it occurs but it beats the alternative. It also usually proffers better times ahead.
- In our view, what is likely an extreme oversold condition in the stock market could become a catalyst for a modest rally before the year's end. We look to the potential for a rally in a number of places including: positive surprises in Q3 earnings season, any reduction in inflation; positive outcomes (perceived or otherwise) from the midterm election in November as well as any progress that develops in addressing Europe's fiscal and energy challenges. In addition some weakening in the dollar could provide a lift to the US market.
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