Stocks Have “Considerably More Downside”

The comments below are an edited and abridged synopsis of an article by Quoth The Raven

Despite the stock market’s recent rally, it continues to carry a large SPY short position. The major indexes—although not all individual  stocks—have considerably more downside to go, the inevitable hangover from the biggest asset bubble in US history.

Stocks Have “Considerably More Downside” - BullionBuzz - Nick's Top Six
3D Isometric Flat Vector Conceptual Illustration of Investing In A Volatile Market, Risky Stock Business

The Fed printed $120 billion a month and held short-term rates at zero while the government ran a record fiscal deficit. Now, thanks to the massive inflationary hangover from those policies, the Fed is reducing its balance sheet and raising interest rates. Although the current rate of year-over-year inflation is unsustainable, the eventual end of China’s zero-Covid policy and its November reversal on bailing out its real estate industry combined with the end of Biden’s SPR drawdowns will give commodity prices a new tailwind in 2023.

Longer term, the war on oil, expensive onshoring, fewer available workers and perpetual government budget deficits make a new baseline of around 4% inflation (double the Fed’s 2% target) likely.

Even a 2023 Fed interest rate pause at 4.75% would, combined with $90 billion a month in ongoing QT, make current stock market valuations unsustainable, as stocks are still expensive.

According to Standard & Poor’s, Q3 S&P 500 GAAP earnings came in at around $44.79, which annualizes to $179.16 (and these were the sixth-highest quarterly earnings in history; i.e., not a trough).

A 16x multiple on that—generous for  a rising rate, recessionary environment—would bring the S&P 500 down to 2867 vs. November’s close of 4080.11. And remember, just as in bull markets PE multiples usually overshoot to the upside, in bear markets they often overshoot to the downside. A bottom formed at considerably lower multiples is possible.

Additionally, the stock market’s valuation as a percentage of GDP (the Buffett Indicator) is still high, and so valuations have a long way  to go before reaching normalcy.

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