The S&P 500 May Soon Be Handed A Harsh Dose Of Reality
Last week saw the S&P 500 (SP500, SPX) posted its first weekly loss in about a month. The culmination of a VIX expiration, Fed minutes, and monthly options expiration helped break the equity market down on Friday and potentially ended the summer rally dead in its tracks.
Now maybe about when things get interesting, with Jackson Hole this week and a slew of Fed officials pushing back against the markets, concluding with Jay Powell himself on Friday, August 26.
While equity markets have been in fantasyland focused on a make-believe dovish Fed pivot, the bond and currency markets have been anchored in reality. That reality shows there is no pivot, and those who bet on a pivot coming will be proven wrong.
The Fed Fund Futures shows us that rates have moved sharply higher since the July FOMC meeting, with two more full rate hikes priced starting in May 2023 until the beginning of 2024. On top of that, the peak rate has shifted from January 2023 to April. The Fed Funds Futures are now pricing in more rate hikes and staying higher for longer.
The big problem is that the S&P 500 earnings over the past twelve months have been around $204, and at 17 times earnings, the value of the S&P 500 would fall to approximately 3,480. But the higher rates have to rise, the lower the PE multiple would need to contract. For example, if the PE returned to the December 2018 low of around 16, the S&P 500 would be worth around 3,200.
In typically equity market fashion, it has become detached, while the reality is again reflected in the bond market, the currency market, and the Fed Funds Futures. Equities tend to be irrational when they either rise or fall, but this time they have become unhinged, and this recent summer rally may fade away even faster than it came to be.
The summer fade may be especially true if Powell can deliver a message that is clear and direct and not one that is two-sided. Add to that a slew of economic data set to be released between September 1 and 3, which may likely support rates going much higher, and staying there for some time.
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