Rules are there to be broken. That might be a standard mantra for anarchists. But for traders, such thinking can prove dangerously dismissive.
Investors should therefore consider the latest note from Bank of America’s Savita Subramanian, in which the star analyst describes how “one line with a perfect track record says the market hasn’t bottomed.”
Subramanian, head of US equity and quantitative strategy, says only 30% of the conditions needed for a market bottom are currently triggered after this latest uptick that has taken the S&P 500 SPX by storm.
an increase of 16.6% from the low of mid-June. Usually at least 80% of the conditions must be registered before the all-clear can be called.
One of these signposts in particular is essential – the rule of 20. That’s when the sum of the annual consumer price inflation and the market’s lagging price-earnings ratio is below 20 when the market bottoms out.
Currently, the market’s P/E is 20 and the CPI is 8.5%, Surbramanian notes. That’s 28.5.
“Except for inflation falling to 0%, or the S&P 500 dropping to 2500, a 50% earnings surprise would be required to meet the rule of 20, while consensus is aggressive and we think already unattainable growth of 8% in 2023.” she says.
Meanwhile, BofA also believes that equities are not cheap enough because the market underestimates the chances of a shrinking economy.
“A 20% chance of a recession is now priced in from 36% in June. In March, stocks had a 75% chance of a recession. Even at Enterprise Value to Sales, where sales should increase at the tailwind of 9% CPI, the market multiple has increased excessively (+40%) over history – possibly because real sales growth excluding energy is essentially flat.
Other signposts that need to be activated to confirm a bottom, but are currently not, include: the Fed’s rate cuts; a decrease of 50 basis points or more in the 2-year Treasury yield TMUBMUSD02Y,
; a rising unemployment rate from its lowest point in 12 months; a buy signal on the sell side.
Signs currently giving the green light to bulls are: Improvement in PMIs; and more bears than bulls.
Given all this, Subramanian prefers the energy and industrial sectors and proposes selling consumer-oriented stocks.
“Industrial companies could be boosted by the already strong capital investment (it grew +19% yoy in the second quarter) and with companies foreseeing even higher capital expenditures during the second quarter of the earnings season. Capex is perhaps more of a necessity in a tight labor market that justifies automation and deglobalization, and should hold up better than in previous recessions,” she writes.
The S&P 500 is down 10% this year. The Dow Jones Industrial Average DJIA,
is down 6%, while the Nasdaq Composite COMP,
has lost 17%.
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