Today is another lift for Wall Street, but at this point a lot of investors are already looking past what could be just another technical bounce off oversold levels. They’re betting that the trend points down from here.
And in that scenario, there’s no point in buying stocks. We need to wait for the moment vulture investors . . . literal “bottom feeders” . . . finally admit that great companies are priced at too deep a discount to ignore.
That’s when a real bear market ends. So let’s go back to recent history and refresh our sense of how cheap stocks get before cash on the sidelines goes back to work.
(And yes, there’s a lot of cash on the sidelines. Warren Buffett alone has $100 billion he needs to invest before inflation makes every dollar smaller. There’s $1.4 trillion stranded in money markets and a record $2 trillion crowded into Fed facilities.)
Right now, the S&P 500 is holding 16.4X forward earnings forecasts. Targets for the current quarter have come down about 1 percentage point but they’ve actually gone up when you look out to the full year. So far, recession rumbling hasn’t managed to make its way to what Wall Street actually expects.
Maybe this is the bottom. If not, skipping the 2020 COVID crash because it was so brief and so unexpected, we look back to the 2018 bear market for guidance. Back then, after all, the Fed was tightening interest rates and supply chains were fraying in the trade war.
The yield curve was even on the verge of inverting. Wary people were already weighing the odds of a global recession.
And stocks that were worth almost 17X earnings at the start of the fourth quarter plunged to barely a 14X multiple. That’s when the buyers swooped back in and the market got back to work.
At the time, anticipated growth rates were a little lower than they are today. If we’re dwelling on gloomy outcomes, say for the sake of argument that Wall Street is aiming 2-3% high on the earnings side of the valuation math.
In that scenario, growth in 2022 will match what we saw in 2019 and stocks could drop another 15% before the vultures start swooping. That takes the S&P 500 back to where it was around November 2020. I think the NASDAQ has farther to go because the pain will be concentrated on mega-tech names like Amazon (AMZN) and Tesla (TSLA).
There’s a fair amount of pain in this math. But then, 2018 wasn’t a fun year at all . . . even if it’s already receded on Wall Street’s rear view. The important thing to remember is that once the vultures swoop, multiples naturally expand from there.
Stocks worth 14X at the bottom will ultimately command valuations 10-20% higher before the cycle flips again. That’s how most of us make the easy money in the market.
What’s different this time? The Fed is more aggressive because inflation is a real and present threat, where it was strangely absent in the last tightening cycle.
But money on the sidelines has urgency on its side now. If people holding cash don’t put it to work in companies they can believe in, the Fed is going to suck that money back out of the economy once and for all.
Crowding into safe havens won’t help. As I write this, the utilities . . . normally “boring” and barely supporting valuations to match . . . are trading at 20X forward earnings. That’s what too much fear in the market looks like.