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Posted by Craig Basinger on Apr 17th, 2023

Glass Half Full

The S&P 500 rallied 7.5% over the past month from the bottom created by the U.S. banking flare-up. Sure, the mega-cap techs helped more than their share, but overall, it has been a decently broad-based advance. 84% of index members are up over the past month. A little over half of index members are also up 5% or more. The TSX is also enjoying a bounce – up 6% over the past month. It’s been a good month with the S&P and TSX bumping up against the top of a range that has existed for half a year now.

Markets hitting the top of this recent range....what next?

There has been some good news to help markets move higher. Firstly, the banking flare-up appears to be fading. Not implying banks are in the clear, but deposits are on the move in search of vehicles with more attractive yields or safer homes. This is negatively impacting some banks (regionals) and benefitting others (money center banks).

Just look at JP Morgan’s latest results; deposits are up nicely. Or look at Blackrock, which enjoyed strong inflows in Q1 to bond and money market investment vehicles. Contagion or a systemic risk does not appear to be an issue.

Inflation has improved as well. This was the market’s biggest angst in 2022, so continued improvement is good news. And while economic growth has been slowing, it has been gradual at this point. The growth has been just enough for bond yields to come down but not too much to raise the market’s ire over recession risk.

10-year yields in the U.S. have now come down from almost 4.5% to 3.5% and in Canada from 3.5% to 3.0%. If you like the porridge analogy for the economy, the data is cool but not cold.

Yields down = multiple expansion, and vice versa

Less inflation and lower bond yields fuelled multiple expansions for the equity markets. The S&P 500 was trading at 16x in late 2022 and is now valued at 18.5x. Meanwhile, the Nasdaq trading at 21x in late 2022 is now back up to 25x – clearly pricing in a good amount of optimism. While 18.5x may not be ‘expensive,’ don’t forget the ‘E’ in the PE ratio is not proving as resilient these days. We are in the early days of Q1 earnings season, which based on current forecasts, has S&P earnings pegged at just over $50. This was nearly $60 last summer. Subsequent quarterly earnings have not been revised down as much. As each quarter’s earnings season approaches, we would expect downward revisions to accelerate. That has been the norm lately.

S&P Earnings estimates continue to be revised lower

The recent high rally in the equity markets is fueled by multiple expansions, thanks to falling inflation and bond yields. However, falling inflation will prove to be a headwind for earnings going forward. And those lower bond yields? Well, they are lower because optimism for economic growth continues to dwindle, which is good for lower yields but not good for future earnings.

Final Thoughts

Future earnings are a bit “squishy.” And with the market enjoying the lift from bank fears cooling, inflation cooling and lower bond yields, could it keep going? Of course. The recent market has been reacting to just about any news as good news: glass half full. And when the Fed finally announces the end of rate hikes, markets may rejoice. However, this advance is being built on a rather shaky foundation. Don’t be afraid to take advantage of this recent bounce and continue pivoting to a defensive position. Or at least be ready to do so in case the market switches to a glass-half-empty mindset.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

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Sources: Charts are sourced to Bloomberg L. P.

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Craig Basinger, CFA

Craig Basinger is the Chief Market Strategist at Purpose Investments. With over 25 years of investment experience, Craig combines an educational foundation in economics & psychology with years of experience in both fundamental and quantitative research. A long-term student of the markets, Craig’s thoughts and insights can be seen in his Market Ethos publications and through his regular contributions on BNN.

Craig and his team bring a transparent and cost-efficient approach to investment management. The team provides asset allocation OCIO services and directly manages over $1 billion in assets. The team manages dividend mandates, quantitative risk reduction strategies and asset allocation services.