The always anticipated “Santa Clause rally” may have come early. From mid-October through early December this year, stocks rallied 17.4%, similar to the 18.9% rally we saw over the summer. Like the summer rally, the S&P 500 demonstrated meaningful weakness last week right at the downtrend line that has proved formidable resistance for the entire year.
In addition, we note some key relationships that we think may signal investor concern about the overall economic and market backdrop.
- Banks find themselves at two-year relative price lows versus the S&P 500.
- Gold has started outperforming.
- Large index weights like Apple, Tesla, Google, and Amazon continue to lag.
- Treasury yields have moved meaningfully lower.
Alone, none of these observations are especially noteworthy. However, taken together, we believe they could be evidence of another risk-off wave building. In our opinion, the near-term risk/reward for stocks is challenged. Current 2023 earnings expectations are $223 for the S&P 500. This is a 5% growth rate, and in our view, too high if the economy enters a recession. As of this writing, investors are willing to pay 18x for every dollar of earnings. Simple math dictates that even if earnings estimates do not fall and valuation levels remain stable, 18 x 223 is about 4,000 on the S&P 500. This represents 2% upside from current levels.
It is perhaps overly simplistic, but we believe this supports our long-held view that stocks are unlikely to return to old highs in the first half of 2023. Investors hoping that a “Fed Pivot” will be the spark the market needs should be reminded that Fed rate cuts are historically bearish.
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