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What Needs to Happen for the Bear Market to End

Dow Jones2022-10-21

The stock market has leapt higher this week, but it needs to hop over several hurdles before it can end this year’s spectacular slump.

All three major U.S. indexes have gained this week, with the S&P 500 up more than 2% in a surge that has been fueled by hope, rather than fundamentals. Investors see a chance that the economic outlook will improve, so they are putting to work the billions of dollars in cash they raised by selling as markets have plummeted. The fact that the S&P 500 is still more than 20% below its all-time high and below key levels adds to the appeal of those bets.

More certainty in several interrelated areas could lead to sustained gains, assuming the news is positive. Without it, stocks could languish, or slide again.

The first issue is how badly the Federal Reserve will damage the economy as it fights inflation by raising interest rates to reduce demand for goods and services. Fed officials have made it clear that the bank is far from easing up on its effort to raise borrowing costs.

More interest-rate increases—and the unquantified, still-to-be-felt effects of those the Fed has already rolled out—means there is a low degree of certainty about corporate profits. Although most companies that have reported their third-quarter results so far have done better than analysts have expected, earnings in coming quarters are likely to be lower than Wall Street has penciled in right now.

No one knows how much lower. A downbeat sign is that while aggregate fourth- quarter earnings estimates for S&P 500 companies have dropped in the past few months, as they generally do as the year winds down, they haven’t dropped as much as they tend to historically. It is striking because this year could be worse than normal for the economy.

The market still needs to identify where economic activity and profits will hit bottom.

It would help if inflation eased, allowing the Fed to slow down its interest-rate increases, but the latest economic data were discouraging. The consumer price index rose 8.2% from a year earlier in September, not far from the peak of just over 9% it hit a few months ago. Interest-rate futures indicate investors expect the Fed to lift its benchmark interest rate to around 5% from 3.0%-3.25% now.

If inflation—and expected Fed rate increases—make a move lower, at least investors would know that there is a limit to the economic damage ahead.

To make things worse, it isn’t even clear whether all of this negativity is already priced into the stock market. There is an argument that it isn’t. While the S&P 500 currently trades at just under 16 times the aggregate per-share earnings its component companies are expected to churn out over the next year, down from more than 20 times to start the year, that multiple may have to fall further.

That is because the yield on 10-year Treasury debt is several times higher than it was at the start of the year, and higher bond yields make stocks less attractive. The S&P 500’s current multiple means that for every $16 invested in the index, an investor gets a dollar of earnings, for a yield of 6.2%.

That is only 2.1 percentage points higher than the 10-year yield, which isn’t a lot of extra compensation for taking the risk of owning stocks rather than ultrasafe Treasury debt. Historically, the expected additional return is around 4 percentage points, according to Morgan Stanley.

“We still think the valuations could get cheaper,” said Marta Norton, chief investment officer for the Americas at Morningstar Investment Management. “They’re not screamingly attractive.”

For bond yields to drop, of course, markets would need greater confidence that inflation will drop and that the Fed will soon slow down in raising rates. Patience is called for.

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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Comment8

  • Tanyl
    ·2022-10-22
    It will drop again on next week 
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  • Susan88888
    ·2022-10-21
    Ok
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  • JoyJoyce
    ·2022-10-21
    Ok
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    • JoyJoyce
      oo
      2022-10-21
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  • jamesjoe0213
    ·2022-10-21
    Good share
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    • HermanL
      good
      2022-10-21
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  • jamesjoe0213
    ·2022-10-21
    Good share
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  • Remotecam
    ·2022-10-21
    When the targetted terminal rate hike keeps going up from 4.2% to now 5.2% (by early 2023), Market will obviously continue to plumment.  520bp is economically crippling.   Inflation needs the war to stop before energy cost goes down. 
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    • MurrayBulwer
      I am pessimistic about the market. Whether it is high inflation rate, tight monetary policy or continuous war, each of them is absolutely harmful to the stock market.
      2022-10-21
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  • koots
    ·2022-10-21
    Gloomy
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    • MOON88
      To the moon soon
      2022-10-22
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  • Hartanto
    ·2022-10-21
    Frc
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