Stocks are definitely on sale, but are they cheap? Markdowns are not always the same as bargains. It all depends on the original price and the quality of the goods. And even with last week’s price declines on Wall Street, it’s hard to say the market is cheap overall. But value appears to be emerging in some corners of the market, perhaps rewarding bargain-hunting amid the “Everything Must Go” clearance event of the past few weeks. The speed, depth and breadth of price declines after last week’s 5.8% loss in the S&P 500, taking its overall decline to nearly 24%, have created rare extremes in persistence. sales and oversold readings. A week ago, this column asked if market conditions had gotten “so bad they’re good” based on the likelihood of a reversal, concluding that things were “probably not quite there globally.” But now, by a variety of metrics, we’re very close, making a significant rebound more likely very soon. The percentage of S&P 500 stocks trading above their respective 50-day average ahead of Friday’s session was essentially as low as it could get, comparable to readings of significant market lows dating back 20 years. Importantly, the comparable tally of stocks above their 200-day average is not yet at such “extreme extremes,” due to the speed of this decline. And the broader bearish momentum gauges are stretching but have room to drop further. The pain has been widespread enough that less than a quarter of index members are still within 20% of their 52-week high. As the chart from Thrasher Analytics shows, this worsened in the Covid crash – a 35% five-week slump – as well as in the bear market of the 2007-2009 financial crisis, an 18-month onslaught that took the market to a peak towards a 12-year low. Many damage assessment studies look like this now, showing the market uncharacteristically washed out by typical standards, the type of setup that is a clear buy in an uptrend market, but less reliable in aggressive downtrends like in 2000-2002 and 2008-’09, multi-year retirements coinciding with deep recessions and presenting successive waves of corporate distress. Shopping opportunity nearby? As stock prices fall, potential forward returns increase, by definition, which promises nothing on timing or trajectory, but steep declines begin to stack the odds in favor of a buyer. Market technician Jonathan Harrier ( @jonathanharrier on Twitter) points out that on Thursday 42% of S&P 500 stocks hit a new 52-week low, only the tenth time since 1985 that this total exceeded 40%. In each of the previous cases (most of which were in 2008 and 2020), there was usually an additional drop – an average of 7.6% over the following month, for example – but the forward yields were much better than the average in the following months. Still, the past week could have been a short-term crescendo of catalysts. From Friday the 10th, the tape absorbed an overly hot CPI report, a leak of the Federal Reserve’s intention to raise short-term rates by 0.75 percentage points instead of the expected 0.5 , the possible three-quarter point rise and hawkish remarks from Chairman Jerome Powell, all leading to one of the heaviest quarterly options and futures expiries ever seen on Friday. What has always been a narrow and rocky path to an eventual economic soft landing has been almost universally branded as even more treacherous and unlikely after the Fed essentially admitted it would have to soften demand and employment a bit until until inflation expectations (primarily a proxy for gasoline prices) retreat convincingly. Yet if you squint, could this also be a short-term spike in the stagflation panic? Crude oil fell 10% and large-cap energy stocks fell 17% on the week, copper and agricultural commodities turned around, and the two-year Treasury yield fell sharply, finishing below its level the moment before the headlines of the Fed’s decision to carry out an oversized rate hike. The market is moving away from the battle-scarred and war-weary week, yes, but also more battle-tested, and emerging with cleaner investor positioning (Morgan Stanley says equity exposure of funds speculative long-short last week hit the lowest level since April 2009, just after the system nearly imploded). Making those judgments is tricky, and the week after the June expiration – this coming week – has been consistently negative for the past few decades, down 25 over the past 32 years. Hard to know how relevant that is after a week of expiry down 5.8%; last year the June expiry week was down 1.9% and the following week the S&P gained 2.7%. The approach to the end of the month should lead to a sizeable rebalancing of the portfolio towards equities after their massive underperformance relative to bonds this quarter and this month. Are stocks cheap? Moving beyond the technical tea leaves and market beats and back to whether lower prices mean good value, here’s where the S&P 500 forward price-to-earnings ratio currently stands. AP/E un just under 16, well off the pre-Covid peak and not far above where it bottomed in earlier selloffs in 2016, 2018 and 2020 closer to 14 times. In the long run, it’s essentially fair value rather than cheap. Various models incorporating interest rates and inflation could make it at the high end of the range, so maybe investors would be lucky if the damage stopped here, like a pendulum stopping halfway. -path of its oscillation. Many will say that this assessment hinges on the reliability of earnings forecasts, which have largely held steady and which most see as likely to decline. This makes intuitive sense, but all previous valuation dips have also come at times when the earnings picture was in serious doubt – which is why valuations crashed in the first place. Either way, S&P earnings estimates outside of energy are already down from the second to fourth quarters, Barclays says, slipping 3 percentage points in recent months. The resilience of stocks to further erosion here will be another test. Away from the marquee index, things look a lot cheaper. The equal-weighted S&P 500 ended the week at 13.1 times forward earnings; it bottomed in December 2018 at 12.9 and March 2020 at 11. Small stocks are becoming much more clearly cheap (and/or signaling a nasty earnings drop), with the S&P Small Cap 600 scraping 10 times earnings, a few blips above the March 2020 low. Certainly some select blue chips are starting to show up in the valuation screens as well. JPMorgan Chase, not far above 9 times expected earnings, nearly fell to the P/E it reached when CEO Jamie Dimon bought shares in February 2016 to help set a bottom for a sharp correction in several months. Best Buy under a P/E of 8 and with a dividend yield of 5% seems to be discounting some scary stuff for the consumer. This is perhaps justified given how consumers have overdone it with durable goods since 2020 and a risky retail future; value traps, after all, are a real danger of buying low. But for anyone who thinks the economy may be more resilient than currently feared, the bargains are starting to fill up.
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