Stock Market Trends, as we are ending February 2023, shows that investors are facing an uncertain market environment, with rising interest rates and economic uncertainty likely to lead to a recession in the first half of the year. This article will explore the current state of the stock market, including the recent inflation spike and interest rate hikes, and provide insights into the potential trends that investors should look out for.
Interest Rates on the Rise
Since June 2022, the Federal Reserve has raised interest rates six times, from 1.5% to 1.75% to 4.50% to 4.75%. As a result, the 1-year US Treasury now pays 5%, more than three times higher than the dividend yield on the S&P 500. This increase in interest rates has had a significant impact on the stock market, with some analysts predicting that stocks could fall by as much as 26%.
Overvalued Stocks and the PEG Ratio
One reason why the market may be vulnerable to a significant correction is that stocks are currently overvalued. The PEG ratio, which is the P/E ratio divided by the growth rate, suggests that the market is expensive and/or has low growth. Compared to historical values, the market seems overvalued. A notorious market bear who called the 2000 and 2008 crashes says that stocks still have 60% further downside as sky-high valuations remain more inflated than every other crash over the last 100 years except for 1929.
Valuations Don’t Look Attractive
The S&P 500 earnings yield today is at historically low levels, at 3%. The best time to buy stocks has been when earnings yield was above 7%. High earnings yield is what drives secular bull runs. Earnings yield serves as a better indicator of the market’s value over time than the traditional P/E ratio. Today’s earnings yield of 3% conveys virtually no upside for long-term investors. Compare that to the historical average of 125%. A low earnings yield, like today, is comparable to valuations at iconic market tops: 1929, 1968, and 1999. When adjusted for inflation, major wealth destruction takes place following these kinds of market valuations.
Cash is More Attractive Than Stocks
Not only are valuations expensive, but cash is becoming more attractive. The spread between SP500 earnings yield to 90-day T-bill shows how much return investors can expect from holding cash as opposed to SP500. A negative spread between earnings yield to 90-day T-bill means cash is more attractive. Historically, this has happened right before recessions and marked significant market tops. This is not a timing tool but speaks to the limited runway for stocks.
Earnings Contraction on the Horizon
Even if valuations stay flat, an increase in earnings leads to an increase in the stock market. Economic growth usually tends to be relatively stable. However, 2021 saw a big spike in spending, thanks to the stimulus package. In 2022, the savings rate collapsed to the lowest level ever seen. As the personal savings rate decreases, the consumer is setting the stage to be in a tough spot once the pent-up savings are used up. Unless consumers get more stimulus, real personal consumption expenditure should revert back to the stable economic growth line. This, by itself, should trigger a contraction in earnings just like it did in 2008.
The Recent Market Correction
U.S. stocks fell sharply on Friday, February 24, 2023, wrapping up their worst week of 2023, after the Fed’s preferred inflation gauge showed a stronger-than-expected increase in prices last month.
The recent market correction has left many investors wondering about the future of the stock market. After years of growth and prosperity, it seems that the stock market has hit a rough patch. The correction has been particularly severe in the early months of 2023, with interest rates rising and economic uncertainties looming.
Rising Interest Rates and Economic Uncertainties
One of the primary drivers of the recent market correction is the rising interest rates. Since June 16, 2022, the Federal Reserve has raised rates six times, from 1.5% to 1.75% to 4.50% to 4.75%. As a result, the 1-year US Treasury now pays 5%, more than 3 times higher than the dividend yield on the S&P 500. This has made cash more attractive than stocks, leading to a significant shift in investor sentiment.
Moreover, the US is likely to experience a recession during the first half of 2023 due to economic uncertainties. This is evident from the recent stock market trends, with stocks being crushed to end the week as inflation spiked, lifting bets on a 50BPS rate hike. Wall Street expects stocks to plunge another 26%, and global stocks are limping towards their biggest weekly fall of the year as rate hike bets accelerate.
Overvaluation of Stocks
Another reason for the recent market correction is the overvaluation of stocks. The PEG ratio, which is P/E divided by growth rate, shows that the market seems overvalued, with higher numbers meaning that stocks are overvalued, expensive, and/or have low growth. Compared to historical values, the market seems overvalued, and this has been a concern for many investors.
Valuations Don’t Look Attractive. The S&P 500 earnings yield today is at historically low levels, at 3%. The best time to buy stocks has been when earnings yield was above 7%. High earnings yield is what drives secular bull runs. Similar starting points have led to 50% returns on a 10-year forward return basis. Compare that to the historical average of 125%. % earnings yield, like today, is comparable to valuations at iconic market tops: 1929, 1968, and 1999. And these low returns are in nominal terms. When adjusted for inflation, major wealth destruction takes place following these kinds of market valuations.
What Does the Future Hold?
The recent market correction has left many investors wondering what the future holds. A notorious market bear who called the 2000 and 2008 crashes says stocks still have 60% further downside as sky-high valuations remain more inflated than every other crash over the last 100 years except for 1929. If the stock market remains falling, that shows the failure resilience of corporate America to sustain, and the FED being the only player to pull up or down the markets.