There were several notable changes to the Market Multiple Table that might seem subtle, but they underscore the shifting narrative in this market and reflect why we believe the next several months could become more volatile (but not necessarily be outright negative).
Scroll down below to download a printable version of this month's Market Multiples Table.
First, one of the market influences changed. “Fed Policy” was changed to “Fed Tapering Timeline.” That may seem trivial, but it is not. Now that the Fed has admitted it is going to taper QE, the only thing the market cares about is 1) When does it happen and 2) How quickly does QE go away. If it happens sooner than expected or QE goes away more quickly than anticipated, that will hit stocks. Conversely, if tapering begins a bit later than expected or is more gradual, that means more QE and that will be supportive of stocks.
Second, expected 2022 earnings continue to rise. We started this year at $205 and now we are up to $215, and that is pushing the “fair value” of this market higher. Again, that provides fundamental support for stocks if we do not get any negative earnings surprises (and that is why we are going to be watching Q2 earnings season so closely, because if earnings growth is disappointing that could be a headwind).
Finally, the multiple for the “best case” scenario got trimmed to 20X because now that the Fed is tapering QE, investors can legitimately expect the market to trade with a 21X or 22X multiple. The net impact is the medium-term ceiling on the market likely got lowered to around 4,500, until such time as investors begin to look at 2023 earnings (which will not happen for a while).
Bottom line, the MMT still paints a supportive picture for stocks, and it is fair to say that while the market is fully valued, it is not crazy ex-pensive, either. However, the margin for error in this market continues to dwindle and as we said earlier, the outlook for the next six months does look more volatile than the past six months, and that is something we will continue to stress until it changes.
Current Situation. The current situation is pretty Goldilocks as the market feels generally comfortable with the Fed tapering timeline, earnings keep getting revised higher, inflation is high but can still be explained as temporary, and the 10-year yield is not rising. The issue, of course, is that this market already reflects this Goldilocks reality and as such it will not provide material upside in stocks until we get incremental improvement. So, conditions are good, but so is the market, and that’s essentially already priced in.
Things Get Better If: The Tapering Timeline is Slightly Delayed, the Labor Market Recovers, Inflation is Anchored, Yields Stay Low and 2022 EPS Expectations Rise.
This is essentially the “best case” scenario for stocks in that the tapering timeline is slightly delayed (but not by enough to stoke inflation), the labor market improves because supply increases (which will relieve wage pressure), inflation expectations do not surge, and the 10-year yield stays stable. This near perfect scenario would lift S&P 500 earnings expectations for 2022 to as high as $225, although given the Fed is removing accommodation the multiple would likely be capped at 20X, keeping further gains more modest.
Things Get Worse If: Inflation or Yields Rise and the Fed Gets More Aggressive on Tapering. The list of things that can “go wrong” evolved slightly from June to July, and now includes 1) The Fed accelerating the tapering timeline or reducing QE more than expected, 2) Inflation rising sharply and/or 3) The 10-year Treasury yield moving sharply higher. If one of those things happen, we are likely looking at a 5%-10% correction. However, if multiple events happen, we are looking at a 10%-15% correction or more.
Bottom line, the MMT reflects the reality that things are pretty good right now, but this is a market that, as things stand, does not have a lot more upside unless we start getting unanticipated positives. So, while it will take a legitimate negative surprise to send stocks sharply lower, we continue to expect a grind slightly higher/sideways until there is more clarity on the issues.
Feel free to use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Email: email@example.com | ivoryhill.com