Four Reasons The Stock Selloff Isn’t Over

Four Reasons The Stock Selloff Isn’t Over

Despite 2022's ongoing selloff, US stocks still aren't priced for the coming economic slowdown. In fact, one popular strategist says, equities aren't even priced for today's macro environment. "Earnings growth is likely to decelerate, driven by margin compression and slowing top-line growth," Morgan Stanley's Mike Wilson said, in the equities section of the bank's mid-year outlook. Wilson, who turned cautious last year after being on the right side of the post-COVID bull market, reiterated th
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11 thoughts on “Four Reasons The Stock Selloff Isn’t Over

  1. Thanks a lot for your always informative perspective. My own thinking has been keen on the very likely impact of the war influencing ongoing inflation. On the other hand, my fingers are crossed that Russia’s ineptitude in making war will shorten the conflict. The poor morale of Russian soldiers and the long-range howitzers that NATO and the US are sharing with Ukraine may help to facilitate a quicker ending. But that process requires time and luck.

  2. Post suggests higher real interest rates. We live in a leveraged economy, higher reals will cause the economy to contract and will lead to lower interest rates. Could we be experiencing another taper tantrum?

  3. I had no perspective about the question of over-capacity. For so many months and years it has been a situation of “if you sell it, they will buy.” I feel it’s peculiar to the landscape in which we’ve been living, where money-printing by the Fed has contributed to a free-wheeling philosophy about spending, most especially by the government. The deceleration Wilson suggests would seem to be a natural outcome. I’ve always found that Morgan does a good job of informing my inflation expectations. The 2023 earnings projections are sobering. I hope it’s just -10%.

  4. My feeling is that 1Q was the bulk of (not all of) the valuation implosion and in 2Q negative revisions will take the limelight. By 3Q those with lots of cash may be able to scoop up bargains.

    A good part of the inflation problem is due to external forces – Russia/oil and China/supply chain. Some more is due to the effect of Covid and a roaring bull market on consumer behavior. These factors are temporary, even if not short-lived enough to be “transitory”. It is possible that in 3Q the inflation tide will be cresting and ebbing, enough for investors to see a glimmer of a Fed put at the end of the Fed tightening tunnel.

    Bottom line, my base case is that buying conditions will return somewhere around 3Q, with maybe some front-running attempts. So chill out, take the summer off, live to fight in the late-summer / fall?

  5. So his “bear” case is only a drop in earning of 10%. That’s not very bearish. Between 2014 and 2015, S&P 500 earnings dropped ~15% and I don’t think that era was referred to as a “bear” market. Prior recessions had the following drop in S&P 500 earnings: almost a 90% drop (2008/2009), almost a 50% drop (2001), almost a 25% drop (1991)… it’s interesting to see that over the past 30 years, each subsequent recession has experienced a significantly larger drop in S&P500 earnings.

    1. Isn’t the S&P heavily weighted to the Tech Oligopoly? It’s hard to see why revenues truly decline 25% for these giant cash vacuum cleaners of Microsoft (Enterprise), Apple (Consumer), Google (Ads), Amazon (ECommerce), etc. The global (market) penetration of tech isn’t complete, and generationally they’re still winning over Boomers (and GenZ purchasing power is going for digital stuff)…
      So it’s a technicality but I feel like the S&P won’t fall as far as those historical drops you listed.

      1. Just as one example: look at the consensus FCF growth for AMZN over the next five years. It is eye-watering, astounding, maybe even risible. Now re-do the valuation assuming FCF growth is merely fantastic. The result is not pleasant.

  6. I run a SP500 valuation model. Bottoms up, for each name pull in consensus FCF ‘22-‘26 and other data, assume a terminal growth (my default is 2%), compute WACC and then a DCF valuation.

    Also, pull in consensus revenues, EPS, EBITDA, book, pull in multiples for selected past period, compute multiple-based valuations.

    If desired, apply some general adjustments like X bp higher or lower rF, Y ppt higher or lower FCF CAGR, different terminal growth, Z points higher or lower multiple, etc. If desired, apply adjustments to specific names. Roll up result by sector and to the index.

    I mostly use this to see which sectors or names look undervalued or overvalued relative to the rest, under given scenarios.

    Sometimes I’ll play with the inputs to see how overall index valuation looks, or what scenarios are discounted at current valuations.

    As you might imagine, the DCF valuation is most sensitive to terminal growth, rF, and FCF ‘22-‘26 CAGR, in descending order. The multiples valuation is most sensitive to what past period you pull the historical multiples from.

    These sorts of models are mostly useful for relative and sensitivity analysis. Who really knows if terminal growth “will be” 2% or 5% – not I! – but it is useful to see how a certain degree of incremental optimism or pessimism can potentially affect prices.

    Broadly speaking, rF +200 bp higher than current could be pretty impactful to SP500 valuation, all else equal. We’re talking a thousand points lower. Cutting CAGR by low-single-digit ppts, to the extent that also lowers expectations for terminal growth, could be similarly impactful.

    The point, if there even is one, is that if macro and/or fundamentals move negatively, in a significant way, there isn’t “valuation support” here.

    I guess that’s Captain Obvious stuff. Just looking at where SP500 is today versus where it was just three years ago would show that too, without all the modeling.

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