By David Rosenberg
The U.S. stock and the bond markets are finally in the process of catching up with our views. We always believed these past two years represented a fake bull market built on sand, not concrete.
And frankly, we also remain steadfast of the view that the inflation scare is going to pass very soon — the bull market is in extrapolation and hyperventilation by economists, strategists, pundits, and media types who can’t seem to see past the tips of their noses. The lagged effects from the supercharged U.S. dollar (IFUS:DXY) is huge in terms of the impact on the cost of imported goods. Inventories have shifted from deficient to excessive and will need to be redressed with price discounts.
The growth in money supply has literally collapsed and there is nary a pulse in money velocity. Fiscal policy, in the span of a year, has shifted from radicalstimulus to restraint that would cause the remnants of the tea party to blush. The cyclical aspect to the commodity bull market is in the rear-view mirror. And as Federal Reserve Chairman Jay Powell myopically focuses on “job openings,” a very soft data point, he is missing the upturn in layoffs and the retreat in company hiring plans. Inflation is going to melt in the coming year, and few (if any) are prepared for it.
I feel like I am reliving the summer of 2008. The stock market is following a familiar pattern of a recessionary bear market. The first phase is the Fed-induced P/E multiple contraction. Typically, the first 20% drawdown is all about how liquidity drainage causes the P/E multiple to shrink — typically by four percentage points in this first installment of the recession bear market.
This time around, the compression has been five multiple points since the early 2022 peak. How perfect. Every recession in the economy necessarily involves a contraction in earnings, which hasn’t happened yet. As I said, it’s all been about the multiple. So far, that is. A plain-vanilla GDP recession, no matter how mild or severe, sees corporate profits decline more than 20% from the peak.
That is the next shoe to drop. It also means that once the analysts start to come to grips with reality and begin to cut their numbers, investors who are dipping their toes back into the market now because they believe that valuations have improved” enough will face their own reality that, no — based on where the consensus will be forced to go on their future EPS estimates — the equity market is not nearly as “cheap” as it appears to be at the moment.
Nobody can ring a bell at peaks or troughs. But there are well-established patterns at the fundamental lows. For one, the recession view has to become mainstream. Analysts have to overdo their downward earnings projections. There is no market trough until the Fed is done tightening, and in a recession bear market as opposed to a liquidity-led drawdown (as in late 2018), it takes actual policy easing to put the market lows in. That is a considerable time away.
The U.S. stock market also needs help from the treasury market for “relative” valuation support. In the past, the end of a bear market in equities required an average 135-basis-point (that’s 1.35 percentage points) drop in the 10-year Treasury (XTUP:BX:TMUBMUSD10Y) yield. Before anyone can turn bullish on stocks, history shows that we need a big bond rally first. Memo to asset mix teams: That means a slice back below 2%.
Also, keep in mind that the dividend yield on the S&P 500 (S&P:SPX) is a puny 1.5% — bear markets do not typically end until the dividend yield converges on the bond yield. This arithmetically means a low for the S&P 500 closer to 3,300. So the answer is no, we’re not there yet.
David Rosenberg is president and founder of research firm Rosenberg Research. Sign up for a free, one-month trial on the Rosenberg Research website.