| || |
With a potential recession on the horizon, we know you want resources to help your business master the moment. We've put together our Agility & Excellence Resource Center to bring you strategies and solutions with a finger on the pulse of what's ahead.
Anna Rathbun, Chief Investment Officer
Catching a Falling Knife
The equity markets have run up year-to-date, and it somehow feels like we are in some sort of an early cycle rebound. So, have we hit market bottom, and is this a rally that signals the beginning of a new market cycle? In other words . . . is the bear market from 2022 finally over? The answers to these questions can become obvious only in hindsight. It is impossible to know when we are in the thick of it, as we are now. But we can glean from history, the 20/20 hindsight, to have the confidence that we are embarking on a new cycle. Here are a few.
- Equity market valuations. Historically speaking, the forward-looking price to earnings ratio (P/E) has been in the lower teens before market has hit bottom. The lowest we saw in October of 2022 was in the mid-teens, and with earnings being revised downward, the P/E ratio continues to be buoyed up. With anticipated weakness in the economy and in earnings, we may see more selloff in the markets before we hit bottom.
- Relative value analysis. When was the last time bond yields were so attractive? If you can earn a respectable income from fixed income, would you take the risk in the equity markets? We can see the relative attractiveness of equity from the premium it offers in earnings yield compared to the yield profile of bonds. Because of 2022’s rate hikes and the upward shift in the U.S. Treasury curve, bonds have become attractive. As of 1/13/2023, the current earnings yield in the S&P 500 Index was 5.2%, but the yield on a 2-year Treasury note was 4.2%. That’s only a difference of a 100 basis points. Historically speaking, one would need to see a larger spread for equities to be consistently attractive.
- Bear market rallies. It is not uncommon to see huge rallies during a longer bear market trend. Such rallies can seem like the beginning of a bull market, and they happen as the economy is in a downward trend. History has taught us that market bottoms do occur while fundamentals still seem scary, but we are usually already about halfway into a recession, and the markets rebound because it sees a way out of it. Right now, the purchasing managers’ indices show that we have just begun to turn downward, and earnings are starting to teether on YoY contraction. From a historical perspective, it seems early for a market bottom.
- Yield curve. The U.S. Treasury yield curve remains heavily inverted. History tells us this is an accurate signal of challenging times ahead. History also tells us that it is often the Fed cutting rates enough to steepen the yield curve that would also coincide with a market bottom.
There is always a chance that “this time, it’s different.” But these financial indicators have been reliable for decades because they reflect human judgment and incentives embedded in how capital moves. Unless human beings have changed, and greed versus fear have been redefined in the markets, I think these are still reliable indicators to tell us the probability of a market bottom. Based on history, that probability seems slim.
The opinions expressed throughout the presentation are those of the author, Anna Rathbun. The information presented does not constitute advice, and you should not take any actions based on a perceived recommendation. If you have questions or would like to make individual financial decisions, consult with your financial advisor.
Investment advisory services provided through CBIZ Investment Advisory Services, LLC, a registered investment adviser and a wholly owned subsidiary of CBIZ, Inc.