Stocks trading at 20x are too rich considering the long odds of central bank rate cuts any time in the foreseeable future.
That was the (familiar) message from JPMorgan analysts led by Marko Kolanovic on Monday.
Suffice to say Kolanovic isn’t abandoning his generally cautious view, which will be one year old in late September.
2023’s equity rally was emboldened last week by a collection of key macro data which together made the case for a soft landing in the US. The economy is expanding, the consumer is feeling pretty good, compensation costs are cooling off, real wage growth is positive again and inflation is moderating. As I put it in the weekly+, “If it could go right, it generally did.”
“Positive news on growth and inflation are fueling optimism for a soft landing scenario in which inflation returns to target, providing space for developed market central banks to ease,” Kolanovic and co. wrote late Monday. “We remain skeptical of this outcome,” they were quick to add.
If you ask JPMorgan, the decline in inflation may ultimately “prove incomplete,” a scenario that’d compel central banks to keep rates restrictive in what’ll feel like perpetuity to some younger investors, many of whom have never operated in an environment where DM rates were as high as they are currently.
Of course, central banks themselves are pushing some version of the “higher for longer” narrative, and on JPMorgan’s telling, higher for longer would “increase private sector vulnerabilities and end the global expansion.”
Stocks pretty plainly aren’t priced for that. The figure below makes the point. “Risk markets are overshooting,” Kolanovic’s team said.
Despite last week’s solid run of data, the bank’s recession probability model still puts the odds of a downturn at 60%, and a JPMorgan composite gauge comprised of “monetary signals” is now “as extreme as in the 70s/early 80s.”
Needless to say, JPMorgan isn’t alone in questioning the rally, but the bearish ranks are thinning the further stocks run. That’s the trap — it’s a “strategist short squeeze,” and at least for now, Kolanovic and Morgan Stanley’s Mike Wilson are keen not to get caught up in it.
“Equity valuations are not pricing a soft landing, but rather a continued expansion (‘no landing’) and simultaneous monetary easing,” JPMorgan said. “With no rate cuts in sight, ongoing QT and our base case for a macroeconomic slowdown, multiples appear too high.”
I don’t know that NTM P/E is the best bear argument. The S&P 500 may be 20x but that’s 493 stocks at 16-17X and the Immortal Seven at WhoCares-X. I think real E (2024) being lower than todays’ consensus +12% from 2023 would be the better bear argument (ref Wilson). If we see that emerging, it might be on 3Q earnings. I think that one reason why bear markets often start in 3Q is that by then it is put up or shut up time for full year numbers. This year, analysts have 3Q as the positive inflection point for EPS growth. So far, I think 3Q guides are generally backing that idea (strictly a vague impression, no actual data analysis). So in early October, the bar will be high-ish because there won’t be that much room to lower it and still believe in 2023 and 2024 consensus. Maybe. I’m just hand-waving and thinking about what could puncture this balloon. I guess we really need to study the earnings trends by sector to make a call.
Not sure where to put this comment, so choosing here.
I occasionally run a spreadsheet that tracks the progress of earnings season.
What I see is: as of 8/1/2023, 59% of the S&P 500 have reported 2Q23. Of those who have reported, 60% beat* 2Q23 consensus revenues and 75% beat 2Q23 cons EPS, 46% had 3Q23 cons rev rise**, 39% had 3Q23 cons EPS rise.
(It is not clear to me if it matters than more are seeing 3Q consensus unch/decline than are seeing 3Q cons rise. It is the middle of earnings, analysts might wait until the dust settles to fully work on next quarter’s estimates.)
I’d be interested if anyone has a Street note looking at this.
“Beat consensus” means the actual was higher than the consensus estimate 1 day before the report.
** “Consensus rise” means cons now is higher than cons 1 day before the report.
To recap, running the sheet for 2Q23 at this point in earnings season (i.e. as of 8/1/2023), it looks like 60% have beaten cons rev, 75% have beaten cons EPS, 46% have seen 3Q23 cons rev rise, 39% have seen 3Q23 cons EPS rise. 53% of S&P 500 had reported by then. 59% of S&P 500 have reported.
Going back in time and running the sheet for 1Q23 at the same point in earnings season (i.e. as of 5/1/2023), it looks like 70% had beaten cons rev, 74% had beaten cons EPS, 55% had seen 2Q23 cons rev rise, 60% had seen 2Q23 cons EPS rise. 53% of S&P 500 had reported by then.
Running the sheet for 4Q22 at the same point in earnings season (i.e. as of 2/1/2023), it looks like 63% had beaten cons rev, 65% had beaten cons EPS, 59% had seen 1Q23 cons rev rise, 65% had seen 1Q23 cons EPS rise. Only 33% of S&P 500 had reported by then. If I run it as of 2/5/2023, when 50% had reported, the numbers are 63% 67% 60% 61%.
Running the sheet for 3Q22 at the same point in earnings season (i.e. as of 11/1/2022), it looks like 61% had beaten cons rev, 63% had beaten cons EPS, 57% had seen 4Q22 cons rev rise, 66% had seen 4Q22 cons EPS rise. 54% of S&P 500 had reported by then.
Maybe looks like weak 3Q, slightly less weak 4Q, signif stronger 1Q, a little softer 2Q? But that could be seasonally typical, don’t know.