Is Bear Market Over? Probably Not

Smartkarma

Contributor:
Smartkarma
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By: Market Radar

EXECUTIVE SUMMARY

  • June: another painful month. The first half of June has been very tough. When markets understood that a 75 bps rate hikes was coming, they quickly reacted and the result has been a new sell-off.
  • The S&P 500 officially entered into bear market.
  • At the beginning, the 10-year Treasury Yield rose at a level close to 3.5%, but then it quickly went down:

DETAILS

Time to see the last market events.

June: another painful month

The first half of June has been very tough. When markets understood that a 75 bps rate hikes was coming, they quickly reacted and the result has been a new sell-off.

The S&P 500 officially entered into bear market.

Here you can see the performance of the most relevant equity indices:

most relevant equity indices

Source: Market Radar on Bloomberg

At the beginning, the 10-year Treasury Yield rose at a level close to 3.5%, but then it quickly went down:

10-year Treasury Yield rose at a level close to 3.5%, but then it quickly went down

Source: Market Radar on Bloomberg

Why the yield started to go down?

One of the possible reasons may be the fear of recession, that is quickly rising. According to Morgan Stanley, there is a 30% possibility to see a recession in U.S. in the next 12 months.

According to Morgan Stanley, there is a 30% possibility to see a recession in U.S. in the next 12 months.

Source: Morgan Stanley

The Federal Reserve will still raise rates in the next meetings, but the market is now pricing a new rate cut for the end of 2023, as you can see in the chart below, that shows the implied overnight rate.

the implied overnight rate

Source: Bloomberg

At the beginning of the year the investors priced a high inflation scenario, while now they are starting to price an incoming recession.

Now the main point is: when markets will bottom?

Let’s see a couple of charts:

S&P 500 Forward 12-Month P/E Ratio: 10 Years

Source: Factset

The S&P 500 is now trading at a forward P/E of 15.8x, well below the 10 year average. This chart would suggest that market are pricing equities in more fair way, but we should make a deeper analysis on the the denominator of the multiple: the earnings.

Consensus earnings estimates have stopped rising but not yet started to decline

Source: Goldman Sachs

The market and the strategists are still expecting growing earnings for the S&P 500, and this is clearly NOT a recession scenario.

In the next chart you can see that during past recessions there has always been a decrease in profits.

during past recessions there has always been a decrease in profits.

Source: JP Morgan

During mild recessions (as it can be the next one), on average earnings declined by 9%.

So, after an initial re-pricing of the multiples, we may now see another leg down for equities, led by a downward revision of the earnings. To sum up, it would not be strange to see the S&P 500 to go down by another 10%-15%.

Where to invest now?

My view has not changed a lot since last market outlook.

I still think that it is better to stay defensive and diversified.

Cash is king in 2022! Better to stay liquid with part of your portfolio. Opportunities will come and you will have to be ready to exploit them.

I am more bullish than one month ago on bonds: if recession will arrive bond yields will start to go down again, and they will even work as an hedge. I think it is time to increase the weight of government and corporate investment grade bonds.

What to say about stocks?

Better to stay cautious! I think we have not seen capitulation yet, so more pain can come. That’s why I think it is better to not buy stocks massively.

I suggest to make a shopping list of several stocks and to proceed step by step: don’t be hasty!

Originally Posted June 29, 2022 – Is Bear Market over? Probably not

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