Bears, Bears Everywhere

More and more, fewer and fewer market observers are willing to countenance the idea that equities have seen the lows.

I suppose that could be a good thing. When everyone (or nearly everyone) adopts a similar mindset, it’s usually wise to question the prevailing consensus. Unanimity can be a contrarian indicator, especially as it relates to pervasive bearishness or rampant bullishness in stocks.

There’s a tendency for folks like Michael Burry and Jeremy Grantham to suggest (tacitly, inadvertently or otherwise) that theirs is the sole voice of cautious reason in a world of cavalier euphoria. They’re everywhere and always keen to cast themselves as Cassandras in a world of Pollyannas. Often, that simply isn’t true.

Every bear market rally — every rebound from oversold conditions or squeeze from extreme positioning — isn’t indicative of “silliness,” as Burry put it over the course of this summer’s fleeting respite for otherwise beleaguered US equities. Sometimes, markets overshoot or at least relative to current conditions, before revisiting the same lows later, once the macro environment deteriorates commensurately. Intermittent rallies aren’t always evidence of renewed bullishness.

Currently, for example, almost everybody seems to share the contention of Burry and Grantham. Stocks are destined to revisit the lows and will likely make new ones as the Fed raises rates into restrictive territory, the economy decelerates and corporate earnings begin to reflect the “reality” of recession. That’s the narrative. And it’s something akin to consensus.

In a 45-page marathon released earlier this week, Goldman walked through a checklist of sorts on the way to concluding that “a genuine bear market trough has not yet been reached.”

The short version is that inflation is set to stay elevated, rates are going higher, growth is set to weaken and valuations aren’t at extremes. The longer version finds Goldman exploring “four sets of conditions that help generate a recovery from cyclical bear markets that include a recession.” Those conditions are “cheap valuations,” “a bottoming in the rate of deterioration in economic activity,” “a sense that interest rates and inflation are peaking” and negative positioning.

On the valuations side, stocks aren’t cheap. They’re not hugely expensive either (or at least not on a holistic measure), but multiples are nowhere near historic lows. Specifically, Goldman used an aggregate measure which includes 12m fwd P/E, 12m trailing P/E, 12m trailing P/B and 12m trailing P/D. “Generally, valuations below the 30%ile of historical averages are associated with positive returns, while extreme high valuations are followed by downturns,” analysts including Peter Oppenheimer wrote.

As the figure (above) shows, global valuations are middling looking back four decades. That points to “modest” positive returns over the next year, but as Oppenheimer cautioned, it’s “only a reliable indicator in isolation if valuations have fallen to extremes.”

Since valuations aren’t at extremes, it’s necessary to look at other indicators. Indicators like ISM. And profits.

The good news is, you don’t usually have to wait on growth to trough for stocks to rebound, equities being forward-looking and such.

“Most bear markets trough around six to nine months before a recovery in corporate earnings per share and roughly three to six months before any trough in growth momentum,” Goldman said. The figures (above) illustrate the point.

The bad news is, ISM isn’t even contracting yet (although plainly, many activity measures are cooling) and forward earnings estimates are still buoyant. We’re not waiting on a recovery in earnings, we’re waiting on them to crack — impatiently drumming our fingers looking for what many top-down strategists still insist will be a deluge of downward revisions.

During what the bank calls the “Despair” phase in the cycle, valuations drop below the 50%ile and ISM is below 46, setting the stage for strong forward returns over a 12-month horizon. “Current conditions are not at these extremes either in valuation or growth,” Oppenheimer wrote.

As for rates and inflation, Goldman noted that concerns around both typically ease as the market heals. For example, markets begin to rebound right before short-end yields begin to fall, and “typically not until the fed funds rate has actually peaked,” Goldman wrote, referencing the figures (below).

I’d note the obvious: The Fed has made it abundantly clear that rates will rise further following this month’s hike. 3.5% is a foregone conclusion, and barring dramatic deterioration in the labor market, 4% is likely before any “pause.”

“At the current time, it is premature to price the peak in interest rates and the prospect for rate cuts,” Oppenheimer remarked. “Equally, economic growth is decelerating and not yet sufficiently depressed to expect the second derivative to be improving.”

Finally, as to positioning, Goldman drew a parallel with valuations and growth: Positioning is only a reliable indicator in isolation when it’s at extremes, which means below the 20%ile.

Sentiment is depressed, but not enough for Goldman to make a definitive call based solely on their indicator, which “is not yet at the levels from which we can be confident of a positive risk asymmetry,” as Oppenheimer put it.

The bottom line: The conditions for a “decisive trough” haven’t been met, in Goldman’s view. That, Oppenheimer cautioned, “suggest[s] further bumpy markets.”

Meanwhile, Morgan Stanley’s Mike Wilson took an axe to the bank’s 2023 and 2024 S&P profit forecasts (figure below). “While we took our first cut to these numbers in our mid-year outlook, we waited to do the larger downward revision until now in order to better time the actual fall in bottom-up estimates, which drive stock prices,” he wrote, noting that in his “experience” (which he jokingly admitted was a euphemism for “prior mistakes”) “it always takes longer for these cuts to play out than it should given the typical corporate optimism about the future.”

Wilson now sees aggregate index EPS falling to $212 in 2023, while profits will be $226 in 2024, according to the bank’s new forecasts. “Our base case tactical view remains that fair value price for the S&P 500 is ~3,400,” Wilson reiterated, noting that the bank expects the benchmark to hit that level “before year-end.”

After that, Morgan Stanley thinks stocks will meander back “toward 3,900” by next summer. In a bear case, which entails a true US recession, tactical fair value is 3,000, Wilson suggested.

Coming full circle, the likes of Burry and Grantham aren’t outliers. They’re not true “contrarians.” Not right now, anyway. Everyone appears to be some semblance of bearish. And virtually nobody is willing to venture an unabashedly bullish call.