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S&P 500 Gravy Train Boarding Now Has Flawed Earnings Assumption

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S&P 500 Gravy Train Boarding Now Has Flawed Earnings Assumption

By Ven Ram, Bloomberg markets live reporter and commentator

Take a loaf of hope, knead it with oodles of optimism, add a generous sprinkling of speculation and definitely avoid even a hint of reality. Bake the concoction carefully, and what do you get? The current state of mind of investors positioning for runaway gains in US stocks.

In January last year, I posited that the S&P 500 will find its equilibrium band for 2022 between 3,900 and 4,130. As it turned out, the average for the year was 4,098. Despite Friday’s dizzying rally in stocks, the S&P is still struggling to breach that band.

At the heart of stocks’ recent optimism is speculation that the Federal Reserve will pivot enough to cut rates this year — a scenario that is largely predicated on inflation and the US economy alike crumbling like a soggy winter cookie. While the macroeconomic backdrop may indeed sour to some extent, it seems premature to conclude that price pressures will wane sufficiently enough to converge to the Fed’s target.

A headline inflation rate of, say, 4%-6% will have the press running breathless headlines about cooling price pressures, but the Fed will still see those rates as unacceptable in reference to where it wants that number to be — a message that Chair Jerome Powell has reiterated umpteen times, only for the markets to gloss over that piece of guidance on an equal number of occasions.

As a basket, the S&P 500 now offers an earnings yield that is about 225 basis points more than long-dated Treasury yields, way below an average of some 375 basis points that has prevailed since the global financial crisis. If anything, the Nasdaq 100 offers a paltry pick-up of 120 basis points.

If you believe in mean reversion, you have got to assume that either stock prices will have to tumble a fair bit from here or earnings need to skyrocket. Even assuming that the latter is what happens, what kind of economic scenario would cause inflation to slow and simultaneously spur earnings to shoot up to the stratosphere? Such a plot would no doubt require an ingenuous recipe, but one you can’t cook up in reality.

Tyler Durden Tue, 01/10/2023 - 10:30

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