Breaking News
Investing Pro 0
🚨 Our Pro Data Reveals the True Winner of Earnings Season Access Data

S&P 500: Bull Case Has 2 Problems

By Lance RobertsStock MarketsDec 06, 2022 04:30AM ET
www.investing.com/analysis/sp-500-bull-case-has-2-problems-200633175
S&P 500: Bull Case Has 2 Problems
By Lance Roberts   |  Dec 06, 2022 04:30AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
 
US500
-1.04%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 

Since the beginning of October, the market has performed better as a “Fed Pivot” bull case pushed investors into the market. We previously laid out the case for a strong short squeeze around the lows of September, stating:

“Currently, everybody is bearish. Not just in terms of ‘investor sentiment’ but also in ‘positioning.’ As shown, professional investors (as represented by the NAAIM index) are currently back to more bearish levels of exposure. Notably, when the level of exposure by professionals falls below 40, such typically denotes short-term market bottoms.

As a contrarian investor, excesses get built when everyone is on the same side of the trade.

Everyone is so bearish that the reflexive trade will be rapid when sentiment shifts.

NAAIM Index Less Than 40
NAAIM Index Less Than 40

The ensuing short squeeze ultimately produced one of the most significant gains on record, with the S&P 500 surging over 5% single day. As we noted, such gains have two primary features. First, they are generally only seen during bear markets. Secondly, while they tend to come in the latter stages of bear markets, they don’t historically denote THE bottom.

Tweet
Tweet

As noted, we expected the rally from the September lows, as discussed in that previous post. However, what was critical was our concluding statement.

“There are plenty of reasons to be very concerned about the market over the next few months. We will use rallies to reduce equity exposure and hedge risks accordingly.

A ‘short squeeze’ is coming, but we aren’t out of the woods yet.”

That remains our positioning currently, as there are two primary issues plaguing the “bull case.”

The Fed… And the Fed

While investors chased the market, hoping the Federal Reserve will “pivot” concerning its monetary policy, the reality is likely substantially different. Such was a point we discussed in The Policy Pivot May Not Be Bullish.”

“The bullish expectation is that when the Fed finally makes a ‘policy pivot,’ such will end the bear market. While that expectation is not wrong, it may not occur as quickly as the bulls expect.

Historically, when the Fed cuts interest rates, such is not the end of equity ‘bear markets,’ but rather the beginning.

The reason is that the policy pivot comes with the recognition that something has broken either economically (aka ‘recession’) or financially (aka ‘credit event’). When that event occurs, and the Fed initially takes action, the market reprices for lower economic and earnings growth rates.”

Fed Funds and Bear Markets
Fed Funds and Bear Markets

Notably, the bull case for a pivot is built on the idea of the Fed ceasing its rate hikes. However, a pivot that would support higher asset prices would require two primary monetary policy changes.

  1. Dropping the Fed Funds rate toward the zero bound;
  2. Reversing “Quantitative Tightening” to “Easing” provides market liquidity.

As the chart shows, these periods of zero rates and monetary accommodation fuel asset prices higher. Periods of balance sheet contraction and higher rates lead to market sell-offs.

Fed Funds + Balance Sheet Contractions vs S&P 500
Fed Funds + Balance Sheet Contractions vs S&P 500

Currently, even if the Fed does slow or stops hiking rates, there is NO indication they are about to reverse course from a “tightening” policy regime to an “accommodative” one.

In fact, just yesterday, Nick Timiraos from the Wall Street Journal confirmed the same. To wit:

“Federal Reserve officials have signaled plans to raise their benchmark interest rate by 0.5 percentage point at their meeting next week, but elevated wage pressures could lead them to continue lifting it to higher levels than investors currently expect. Brisk wage growth or higher inflation in labor-intensive service sectors of the economy could lead more of them to support raising their benchmark rate next year above the 5% currently anticipated by investors.

In other words, the most significant challenges to the bull case remain the Fed not cutting interest rates and the Fed not engaging in “Quantitative Easing.”

Playing The Probabilities

While the history of financial interventions and market performance is quite evident, there is always a possibility “this time could be different.”

Yes, it is possible the bull case could mature if the economy avoids a recession, earnings stabilize, and inflation falls. However, given the lag effect of restrictive monetary policy (i.e., higher rates) and demand destruction, the risk of a recession is elevated. As such, earnings have not adjusted nearly enough to account for the reduction in consumer demand.

SP500-Forward-EPS-Drawdowns
SP500-Forward-EPS-Drawdowns

More importantly, the “lag effect” of monetary tightening has yet to reflect in the economic data. While the economy is slowing somewhat, employment has yet to contract. Already, we are seeing a sharp decline in CEO confidence as more companies lay off workers and institute hiring freezes. As shown, such eventually translates into higher unemployment, slower economic growth, and reduced expectations for future earnings.

CEO-Confidence vs Jobless-Claims
CEO-Confidence vs Jobless-Claims

As noted, anything is possible. However, as investors, we must “play the probabilities” for the current economic environment. The Fed hikes rates to quell inflation by creating “demand destruction” in the economy. Such will lead to higher unemployment, slower economic growth, and reduced earnings. All of which are not supportive of higher asset prices or elevated valuations.

Yes, the market could defy fundamental realities and front-run the Federal Reserve to the next round of monetary accommodation. However, given that strong market rallies curtail the Fed’s efforts, the bull case may keep the Fed in a restrictive mode longer than anticipated.

It seems to us that the bull case may be too far ahead of reality. If that is true, being a little more cautious and selling rallies may hedge the risk one final leg lower in 2023.

S&P 500: Bull Case Has 2 Problems
 

Related Articles

S&P 500: Bull Case Has 2 Problems

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.
  • Any comment you publish, together with your investing.com profile, will be public on investing.com and may be indexed and available through third party search engines, such as Google.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (7)
Scott Bradford
Scott Bradford Dec 07, 2022 1:06AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Super solid article
Pa Ag
Pa Ag Dec 07, 2022 12:05AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Super charts Lance!
Lina Lender
Lina Lender Dec 06, 2022 10:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
good evaluation
Kevin Eddlemon
Kevin Eddlemon Dec 06, 2022 9:19PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Good article
Roger Pruzansky
Roger Pruzansky Dec 06, 2022 4:28PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
except adamo projected eps with toward guidance. the truth is as for the stock market this century we are ducked.
Adamo Nals
Adamo Nals Dec 06, 2022 2:33PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
SImple. $200 a share times 14X is $2800 s&p. Its that simple. Everyone has forgotten math and fundamentals. 70% of stocks in the market are overvalued. Apple. Fair value 90-100$. Amzn. 11-12$. Msft $150-165. Etc etc etc. other than energy everyone should be buying now. Thats it. Simple.
Bubba Born
Bubba Born Dec 06, 2022 2:33PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Based on your statement criteria of 14X earnings, everyone should be selling now.
Kris Jay
Kris Jay Dec 06, 2022 2:33PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
well 15x anyway is the average over 10 years.  but sure we should be at SP500 3000, not 4100 like last week.
Jeff Page
Jeff Page Dec 06, 2022 6:38AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
I just keep my eyes on the CAPE ratio, earnings are being compressed.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email