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The Sell-Off In Stocks May Have Only Just Begun

Published 02/26/2021, 05:11 AM

This article was written exclusively for Investing.com

Stocks have fallen sharply, and the decline should not come as a surprise to anyone. Valuations in many equities have been at historically high levels. Now that rates have risen, the equity market is in the middle of a massive repricing.

The big move higher has been driven by the concept that low-interest rates could expand PE multiples. But rates have risen sharply in recent weeks. These higher rates are making the stock market more expensive when compared to bond yields. If stocks need to reprice for this shift in rates, it could result in a rather steep equity market sell-off, perhaps more than 20%.

The S&P 500 has seen its PE ratio rise to historically high levels since the March 2020 lows. In fact, they have reached levels not seen since the late 1990s, with the S&P 500 now trading at roughly 22 times 12-month forward earnings estimates of $176.03. That is the highest the valuation has been on a forward earnings multiple since the early 2000s.

When valuing the S&P 500 on an earnings yield basis versus 10-year breakeven inflation expectations, one would find that the valuations are at extremely high levels. With a spread currently at 2.5% versus a 200-day moving average of 2.8% and a historical average of 4.24% since 1997, it would imply that rising rates on the 10-year Treasury and 10-year TIPS could harm equities, resulting in a massive repricing.

Earnings Yield To Inflation Expecations

Over the last 5 years, the average spread between the S&P 500 and 10-Year Breakeven Inflation Expectations has been around 3.9%. Assuming that spread rises to the historical average of 3.9% would push the earnings yield on the S&P 500 back to roughly 6%. That would give the S&P 500 a PE ratio of around 16.5, based on forward earnings of $176.03, the index could fall to approximately 3,000, a drop of about 27%.

It seems like technology stocks have seen a lot of multiple expansion over the past 12 months and could be the hardest hit in a repricing environment triggered by rising rates. The significant and steady growth rates became a safety net for those investors looking for a place to park their money.

For example, Amazon (NASDAQ:AMZN) is trading at 3.2 times 12-month forward sales estimates, which is at the upper end of its historical range and well above its average of around 2. Meanwhile, NVIDIA (NASDAQ:NVDA) has seen its PE multiple climb to approximately 45 times 12-month forward earnings estimates and is at the very upper end of its 5-year range.

Amazon

The banks, however, have been one of the big winners recently. While they could undoubtedly get pulled into a downdraft, they are likely to benefit longer-term. Rising rates on the long-end of the yield curve have helped steepen the curve dramatically. It is likely to help the banks’ revenue and net interest income boosting profits.

Stocks like JPMorgan (NYSE:JPM) or Bank of America (NYSE:BAC), although not cheap at current levels after seeing a massive run-up, could undoubtedly become attractive in a broader stock market pullback. Especially if the rising rate environment comes with continued economic growth.

A market drawdown would undoubtedly be welcome after the euphoric run it has had over the last 12 months. Trying to predict a pullback is never easy and not a task to take lightly. But the rising rate environment and richly valued stock market seem to have all come together, creating a perfect storm.

Latest comments

Wow! you kept this up. Even with $2T of fake money headed into the market with only 6% targeting Covid you thought there'd be a sell off. Keep the day job, as this one isn't for you.
I think it ended.
Last time they thought bond yields would have a dramatic effect they were way off and cost a lot of people a lot of money. This is the end of terrible times and people are ready to spend that cash theyve had in their bank accounts to live again. With JNJ vaccines the covid shot will be the new flu shot and everyone can live life again. Things are looking good. Sure there will be a little correction but dont listen to the doom sayers.
You can see inflation building very clearly in higher oil, industrial metals and agricultural prices. This is no mirage. That is why bond yields have been rising, and will rise further. Stocks can only compete with higher dividends and one way to achieve that is with lower share prices; the alternative is to raise profits and that is much tougher during a global economic depression, and what else do you call it? Stocks are way too high for the economy we are in and face going forward.
Pull out and wait for the correction unless your just a long term holder and not a short term trader. I love pull backs because I am an options trader. Puts all the way down and calls all the way back up again.
To be out of the stocks market for a while seems necessary , maybe bonds can be bought . The question is for how long ?
What are you suggesting? To put money in bonds lmao? Or take our money out and do nothing with it? What would be the point of that? You want to grow your money you either have to gamble with something like crypto or just keep it in the market.
the sell off in stocks may have just ended
Well said
That was no sell off. It didn't even break out of a daily trend. Bounced off the 50 day SMA. A sell off would hit or break the 100 day at least.
When they are negative that's the time to buy. When they are positive, they are trying to scrw you.
this guys and 99% of the articles on this website are to scare the small investor. Just skim the article, realize its not logical and carry on buying the dip on these suits. retail for the win. buy quality companies and make them realize were here to stay. any suits looking for a job, I think the publix deli is hiring. We don't need "financial advisors" stealing from us, trying to do for us what most people are capable of doing themselves. 2021, let's rip it boys. 15%-%20 on the Nasdaq. bulls gonna shred.
Should start pedge funds... the peoples band together to hedge and reward companies helping main street
Sellers dream
He is always late at “current” news
Amazon is bad example coz it is trading below August 2020 for long time and parabolic during September 20- February 21
Good article! If the S&P trades lower on the year (3748.75) you could see a replay of 1987 when all the fund managers had to sell. Tuesday is the 9th day which is usually the selling climax. Don't buys the dips!!
Easy ti say after it started. Where was this guy 2 weeks ago?
classic example of 'noise'
🌈 🐻
simple clear thinking.thanks a lot
Hallo Sir
Hello mia
If next week we see a reversal in US10Y rates, maybe triggered by statements from FED governors, would you expect SP500 continue its upward trend ? 1 Million USD question :)
All this is are institutions taking their bonuses out while QE and interest rate is low.
I see many people with a firm belief in socialism, albeit a federal one. That's good. In many perspectives.
I already lost 10% of my investments. And some people say I should wait to sell? In a matter of days I would see 20% loss. I'm sure.
I'm down 20 percent already
 so you are down 60 overall?
It depends on stocks in your portfolio If you have Apple it will be back easiely for sure
I don’t think the heavy stuff is gonna come down for quite some time.
Well hello shorty. Probably best to take your profits because your beloved bottom is reached sooner than later.
I always see him spamming his articles that appear here and on seeking Alpha to other stock trading forums. Talk about a guy who claims no positions but has to be very short on everything and has a huge losing streak. I'm just surprised both sites have not banned his nonsense.
likewise - exactly my thoughts about him. Every word bro. 👌
20 percent lmao youre a joke
Fed will most likely intervene and start buying bonds if the yields do not decrease on their own in a week or two. It is funny how people have 0 faith in the establishment these days. Calm down and think rationally. Invest, don't gamble. It is obvious that Fed will do whatever it takes ti get the economy back on track and that means keeping rates low for the foreseeable future, meaning at least 2-3 years.
print more, then USD goes down, inflation will have even more fuel, rates cannot be kept down 2-3.years, only a few months, don't trust Fed, they are liars
As far as my knowledge goes FED currently buys $120 bln./month bonds. Even socialists without a free market reach a cap on printing.
Fed has UNLIMITED printing power; the Fed could DECIDE not to print or to print less, but that would based on a decition, not on a limitation which does not exist
Dude you are a just a negative man
He put a big money for shorting
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