- Earnings season may help to give the S&P 500 a much-needed boost from oversold levels.
- However, monetary policy will continue to be the biggest head for the equity market
- Tighter monetary policy will stand in the way of any long-term rally
It is now the fourth quarter of what has been a horrible year for stocks, with the S&P 500 down about 25%. While the market is again at an oversold point, earnings season is about to kick off, with the potential to deliver a short-term rebound that may be welcomed but is unlikely to last.
The most challenging issue facing the market for the rest of the year and probably for the first half of next year will continue to be the path of monetary policy. The decline in the Fed’s balance sheet amid tightening financial conditions has been the story of 2022 and is likely to be the story for at least the first quarter of 2023.
Strong Nominal Growth Lifting Revenue
The market will likely see a decent bounce in the coming weeks as earning season rolls around. Earnings estimates overall are on the decline, but one shouldn’t be surprised if they come in better than expected.
One reason is that sales estimates for the S&P 500 remain strong and are still trending higher. Sales estimates are a function of nominal economic growth, not real economic growth, and should be thought about in nominal terms.
It is why sales estimates have not only held up but increased after two consecutive quarters of negative real GDP growth. Because over the same time, as real GDP has fallen, nominal GDP has continued to rise, and sales estimates are just following nominal GDP higher. So as companies report results this quarter, it would not be surprising to see numbers come in stronger than estimates, especially on the revenue side of the equation.
This could give investors the hopes and dreams that all will be ok, and it could even rally the equity market for a couple of weeks. But that will change the path of monetary policy, and by then, the Fed will be on course to raise rates to between 4.25% and 4.50%, and potentially higher following today's hotter-than-expected CPI report and keep them there for some time.
Alternatives
Additionally, stocks are already expensive compared to bonds, and any rally in equity prices will make them more expensive. Unfortunately, for the first time in more than a decade, there is an alternative to stocks, and that makes stocks less attractive.
The spread between the S&P 500 dividend yield and the 10-year Treasury has risen to more than 2%. That is the widest the spread has been since 2010 and equivalent to periods not seen since the mid-2000s.
S&P 500 PE Ratio Is Still Too High
The problem is that the last time the spread between the dividend yield and the 10-year was this wide was in the mid-2000s, and the PE ratio of the S&P 500 traded at lower valuations. Over that period, the PE ratio traded as low as 14, versus today's valuation of 15.7. It is not much lower, but it suggests the potential for the S&P 500 to still head lower from its current levels.
Additionally, if the 10-year rate should continue to rise, it is only likely to widen that spread further, which means that the S&P 500 dividend yield would need to keep pace with a rising 10-year. As the dividend yield falls, it pushes the value of the S&P 500 down.
At this point, the equity market can get that very much-needed relief rally as earnings approach or come in better than feared. It seems unlikely that a long-term uptrend in the equity market isn't likely to start until the Fed’s monetary tightening cycle is over.
Disclosure: Charts used with the permission of Bloomberg Finance LP. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer's views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer's analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer's statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments based on that index. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment. Michael Kramer and Mott Capital received compensation for this article.