Stocks Are Strongly For Sale, But Are They Cheap? Discounts are not always the same bargain. Much depends on the original price and quality of the goods. And even with last week’s falls on Wall Street, it’s hard to say the market is broadly cheap. But value appears to be developing in some corners of the market, potentially rewarding the hunt for good bargains during the last few weeks’ Everything Must Go clearance event. The speed, depth, and breadth of price declines following the S&P 500’s 5.8% loss last week, which took its overall decline to nearly 24%, has led to rare extremes in sell persistence and oversold readings. A week ago, this column asked if market conditions were “so bad it’s good” based on the likelihood of a reversal, concluding that things “probably aren’t quite there.” But now we’re very close by a variety of metrics, making a meaningful bounce more likely very soon. Washed Out The percentage of S&P 500 stocks trading above their respective 50-day moving averages was essentially as low as it gets, comparable to readings from significant market bottoms 20 years ago. Importantly, the comparable number of stocks above their 200-day moving average has not yet reached such “extreme extremes” due to the speed of this decline. And broader downside momentum is stretched but has room to fall further. The pain has been so widespread that less than a quarter of index members are still within 20% of their 52-week high. As Thrasher Analytics’ chart shows, this became even worse in the Covid crash – a five-week collapse of 35% – as well as the 2007-2009 financial crisis, an 18-month onslaught that took the market in one to 12 years -Indicate deep. Many of the damage assessment studies now look like this, showing that by typical standards the market is unusually washed out, the kind of setup that is a clear buy in an uptrend market but is less reliable in aggressive downtrends like in 2000. 2002 and 2008-’09, multi-year pullbacks that coincided with sharp recessions and featured successive waves of corporate distress. Buying opportunity nearby? By definition, when stock prices fall, potential returns rise, which promises nothing about timing or path, but large declines begin to tip the odds in a buyer’s favor. Market tech Jonathan Harrier (@jonathanharrier on Twitter) points out that on Thursday, 42% of S&P 500 shares hit a new 52-week low, only the 10th time since 1985 that total surpassed 40%. In each of the previous cases (most of them in 2008 and 2020) there was generally further downside – for example an average of 7.6% over the next month – but futures yields were quite a bit better than average in the following months. Still, last week may have been a short-term crescendo of catalysts. Beginning Friday the 10th, the tape picked up an overheated CPI report, a leaked Federal Reserve intention to raise short-term interest rates by 0.75 percentage point instead of the expected 0.5 percentage point, an eventual hike of three quarters of a point and hawkish Talk from Chairman Jerome Powell, all of which resulted in one of the hardest quarterly options and futures expirations on Friday. What was always a narrow, rocky road to a possible soft economic landing was almost universally heralded as even more treacherous and unlikely after the Fed essentially admitted that it would have to moderate demand and employment quite a bit until inflation expectations (mostly a proxy for gasoline) prices) are convincing withdraw. But if you squint, could it be that it was also a short-term peak in the stagflation panic? Crude oil fell 10% for the week and large-cap energy stocks fell 17%, copper and soft commodities turned around and the two-year Treasury yield fell sharply, ending below where it was right before the headlines of the year The Fed’s decision to launch an outrageous rate hike. The market is lagging the week, battle-hardened and war-weary, yes, but also more battle-hardened and emerging with cleaner investor positioning (Morgan Stanley says long-short hedge fund equity exposure last week hit its lowest level since April 2009, shortly after the system was almost imploded). It is difficult to make such judgments, and the week after June – this coming week – has been consistently negative for the last few decades, down 25 of the last 32 years. Difficult to assess how relevant after an expiry week of -5.8%; last year the week of expiry was down 1.9% in June and the following week the S&P gained 2.7%. Towards the end of the month, equities are likely to see some significant portfolio rebalancing after having massively underperformed bonds this quarter and month. Are stocks cheap? Moving beyond the technical tea leaves and market rhythms and back to whether lower prices mean value for money, here’s where the price-to-earnings multiple of the S&P 500 sits right now. AP/E slightly below 16, well below pre-Covid high and not far above where it bottomed closer to 14x in previous severe sell-offs in 2016, 2018 and 2020. In the long run, this is essentially fair value, not cheap. Various models incorporating interest rates and inflation might reflect it at the top end of the market, so investors might be lucky if the damage stopped there, like a pendulum halting midway through its swing. Many will say that this valuation depends on the reliability of earnings forecasts, which have largely held up and are viewed by most as likely to fall. That makes intuitive sense, but all previous valuation lows also came at times when the earnings picture was seriously challenged – which is why valuations collapsed in the first place. In any case, non-energy S&P earnings estimates are already falling for the second through fourth quarters, Barclays says, slipping 3 percentage points over the past few months. Stocks’ resilience to further erosion will be another test here. Away from the marquee index, it looks significantly cheaper. The equal-weight S&P 500 ended the week at 13.1 times expected gains; it bottomed out at 12.9 in December 2018 and 11 in March 2020. Smaller stocks are becoming much more cheap (and/or signaling a nasty earnings slump), with the S&P small cap 600 ending 10x gains a few Outlier scrapes above March 2020 low. Select blue chips are sure to show up in rating screens as well. JPMorgan Chase, not far above 9 times expected earnings, is down close to the P/E ratio it hit when CEO Jamie Dimon bought shares in February 2016 to help hit a low for a brutal multi-month correction. Best Buy is trading at under 8 times earnings and with a 5% dividend yield, which seems to be pricing in scary things for the consumer. Perhaps this is justified given the way consumers have overdone it since 2020 with durable goods and a precarious retail future; After all, value traps are a real danger when buying cheap. But for those who believe the economy may be more resilient than now feared, the bargains are starting to fill up.
