Once a month, on the fourth Thursday of the month, I will put up a long term view of the market. This is provided for investors who don’t want to trade secondary swings in the market, but would like to exit the stock market relatively soon after a bear market begins, or enter the market after a new bull market begins (change in the primary trend). In the blog, they will always have a title called “Long Term (month) (year)”, so you can use your browser “Find” function and easily find them.
Economics:
GDP – The third estimate of 2023 Q1 GDP is +2.0%, revised up from +1.3% at the second estimate. Many economists think the long term growth rate of the US, without artificial stimulus, is about 2%.
The June 27th Atlanta Fed GDPNow estimate of Q2 GDP is +1.8%. That’s the best estimate that I have access to, but they were off last quarter (+3.2% estimate, +2.0% actual for Q1).
The economy continues to expand, but the rate of expansion has slowed. When inflation heats up a company’s cost go up, so they raise prices to the consumer. The consumer pays them for a while, but eventually the less affluent consumer will switch to a cheaper product or just quit buying that product. The company’s revenue starts to fall, and so do their profits. They need to get their cost down and that usually involves layoffs. Those laid off workers drastically cut back spending and other companies see their revenue fall. If the damage is widespread enough the economy falls into recession. We’re not there yet.
This is neutral for the stock market.
| Year | Quarter | GDP % |
| 2023 | Q1 | 2.0 |
| 2022 | Q4 | 2.7% |
| 2022 | Q3 | 3.2% |
| 2022 | Q2 | -0.6% |
| 2022 | Q1 | -1.6% |
| 2021 | Q4 | 6.9% |
| 2021 | Q3 | 2.0% |
| 2021 | Q2 | 6.7% |
| 2021 | Q1 | 6.4% |
| 2020 – Covid | Year | 0.1 |
| 2019 | Year | 2.3 |
| 2018 | Year | 2.9 |
| 2017 | Year | 2.6 |
| 2016 | Year | 2.0 |
Fed interest rates – At the June meeting, the Fed left rates unchanged at the Fed Funds rate of 5.25%.
Inflation has slowed a bit and interest rate increases impact the economy estimated at a six month lag. Powell at the Fed press conference on June 14th reiterated the Fed’s commitment to bring inflation back to their target of 2%, and he acknowledged that inflation has come down. However, he indicated that most of the Fed governors felt that additional rate increases would probably be advisable in 2023 to continue to bring inflation down. That was called a “hawkish pause”.
The other thing the Fed is doing is Quantitative Tightening (QT), which means they are not buying bonds to replace those that they hold when they mature, and outright selling bonds into the secondary market. This will force private companies and individuals to buy the bonds, and then those dollars are not available to buy TV’s, boats, or other big ticket items. Money is going out of circulation shown by a outright decline in the M2 money supply, which does not happen often.
Local and regional banks have tightened lending standards making it harder for small and medium businesses to get loans to expand. That will slow the economy down somewhat.
Fed policy is restrictive for the economy, and bearish for the stock market.
| Date | Fed Funds Rate | 5 Year Treasury | 10 Year Treasury | 30 Year Treasury |
| Jun 2023 | 5.2 | 4.0 | 3.7 | 3.8 |
| May 2023 | 5.2 | 3.8 | 3.7 | 4.0 |
| Apr 2023 | 5.0 | 3.5 | 3.4 | 3.7 |
| Mar 2023 | 5.0 | 3.6 | 3.5 | 3.7 |
| Feb 2023 | 4.7 | 4.2 | 3.9 | 3.9 |
| Jan 2023 | 4.5 | 3.6 | 3.5 | 3.6 |
| 2022 Q4 | 3.9 | 4.0 | 3.9 | 4.0 |
| 2022 Q3 | 2.5 | 3.4 | 3.3 | 3.3 |
| 2022 Q2 | 0.8 | 2.9 | 2.9 | 3.0 |
| 2022 Q1 | 0.2 | 2.0 | 2.1 | 2.3 |
| 2021 Year | 0.2 | 0.8 | 1.4 | 2.0 |
| 2020 Year | 0.4 | 0.6 | 0.9 | 1.6 – Covid |
| 2019 Year | 2.2 | 1.9 | 2.2 | 2.6 |
| 2018 Year | 1.8 | 2.8 | 2.9 | 3.1 – Tax Cut |
| 2017 Year | 1.0 | 1.9 | 2.3 | 2.9 |
Valuation:
S&P 500 earnings – Factset shows that for Q2 of 2023 projected earnings are -6% vs. Q2 of last year. If that is how they come in, we would have Q4 2022 at -4%, Q1 2023 at -2%, and projected Q2 2023 at -6%, and that is not a pretty picture. It is unusual for earnings to show an outright year over year decline. Normal year over year earnings growth is about +5%.
The forward PE for the S&P is 19 compared to the ten year average of 17, but remember, the forward PE is just a guess and nobody’s guess has been very good lately. The bear market has done its job and brought the stock market from dangerous overvaluation 2 years ago, down to more normal valuations. The question is, will the interest rate hikes cause a recession later this year that will take the market valuation down from normal to attractive level, with a PE in the low teens?
Higher interest rates crimp corporate earnings. Inflation causes workers to get a raise on their current job, then look for a new job and get another raise to change jobs. That is a way to keep up with inflation, and in some cases to break out ahead. The old employer often finds they have to pay more to replace someone, and sometimes the new employee is not as good as the old one (but sometimes you find a better employee, it’s not a predictable process). It all puts pressure on the bottom line, on corporate earnings. Then a company’s stock will get knocked down. Now the CEO and his/her top 8 executives are strongly compensated to keep the stock price up. What can we do to keep the stock price up in the face of these cost increases? We can get creative and look for ways to save money. You look for places to cut “stuff”, like travel, you can use the phone instead. And then you can cut “people”, the venerable corporate layoff. We have not seen the unemployment rate rise noticeably yet, but we probably will. Then the economy will slow some more. That is what classically happens. Will it happen that way this time? I think so, but I’m not certain.
The 12 month forward “operating earnings” estimate on the S&P 500 from the Standard and Poor’s company is $222, unchanged from last month. The more bearish analysts like Mike Wilson think the S&P company estimate is too high, Mike thinks $200 is more realistic for 2023. That is a large difference of opinion.
The outlook for earnings is bearish, below the long term trend of +5%.
PE on S&P 500 – The current 12-month trailing GAAP PE on the S&P 500 is 25, up from 24 last month and down from 31 in the summer of 2021. I used 4 quarters of earnings with the most recent being Q1 2022. I used the same earnings as last month, but stock prices have rallied nicely in June, so the valuation is higher.
This metric is moderately overvalued relative to my trimmed 30 year average of 19. I trimmed out the quarters during recessions for my 30 year average, since the P/E behaves very abnormally during those times. I go in 5 point increments for my terminology, so 20 – 25 would be moderately overvalued, while 25 – 30 would be significantly overvalued. Above 30 would be dangerously overvalued. On the downside, I will go with 14-18 being moderately undervalued and 9-13 being significantly undervalued. As a last resort, I will go with 4-8 as being egregiously undervalued, and hope we never see that because all investors will be in pain at that point.
This indicator is bearish.
Age of primary move, bull or bear market – This bear market is 1.5 years old. This is neither bullish nor bearish, but it is worthwhile to keep it in mind.
Geo-Political: (no change from last month)
Liquidity: Central banks globally are withdrawing emergency accommodation for Covid. They are tightening financial conditions by raising interest rates to fight inflation.
US / China: It appears that the US and China are engaged in a tug of war to see who is the world’s economic leader. China has advantages in low cost labor and some natural resources such as rare earth metals, but they lack oil and natural gas. China developed the ability to produce advanced electronics with the aid of the US, but the primary market for those items is the US and Europe. The US has long been a technology leader and we have sophisticated financial markets that are usually well regulated.
Ukraine: Thewar in Ukraine drags on. Ukraine is having more success on the battlefield than most expected, with the help of western weapons. Russia is destroying much of eastern Ukraine’s cities and rebuilding will be difficult. Sanctions against Russia are disrupting commodity markets since Russia was such a large exporter or oil, natural gas, and metals. Ukraine was a large exporter of wheat and other foods and that export is hindered by the war. It appears that after the initial shock in the commodity markets when Russia invaded, prices have stabilized and the world is dealing with new sources and trading patterns.
Geo-politics is currently bearish, mainly due to the war in Ukraine and global central banks tightening.
Technical:
Technically the chart below is positive near term (months), and still positive longer term (year).
RSI at the top of the chart is neutral at 58 and rising. Momentum shown by MACD at the bottom of the chart is neutral and looks like it is trying to turn up. The price action is positive both near and longer term.
So, does that mean we should go put all of our chips in the stock market? No, not in my opinion. A chart is a tool. I like a multi-prong approach where I look at other indicators. You put them all together and come up with an overall outlook.
Chart is a ten year chart of the S&P, each candlestick represents the price range for one month.
This is positive in the short run, and remains bullish longer term.
Conclusion:
- GDP growth is neutral with Q1 GDP rising by 2%.
- The Fed has short term rates at 5.25%. That is restrictive and bearish.
- S&P earnings for Q1 are 2% below Q1 2022 which is below trend and bearish.
- The PE valuation of the S&P based on the 12 month trailing GAAP number is 25, which is moderately overvalued and bearish.
- The geo-political factors are bearish.
- Technically the chart looks bullish short term, and bullish longer term.
By that way of looking at it, the market is bearish, with four factors bearish and one neutral and one bullish.
Long Term Issues to Keep in Mind:
National Debt:
(December 2022) – The national debt stands at $31.5 trillion.
(Updated March 2020) – Covid 19 begins. Well this is going to get a lot worse. Looks like the politicians are going to be printing money and dropping it from helicopters. But all the other major economies will do the same thing, so relatively, the dollar may not drop much (which would be bad for inflation).
(Negative – Noted Jan. 2018) The deficit will go up despite the republicans saying that if the tax cut bill is “dynamically scored” using “possible” increases in economic activity, it will hold down the deficit by increasing tax receipts. This has not been shown to work in the past. The US added $980 billion to the national debt in fiscal 2019 (ended 9/30/2019), a tragedy in good financial times.
(Late 2020) – The total national debt exceeds $26 Trillion, and as interest rates rise, the component of the annual budget allocated to “interest on the debt” will increase, putting pressure on existing programs, or increasing the deficit. If the deficit is allowed to rise too much in good economic times, the value of the dollar will fall and that is inflationary which is usually bad. The thing saving us today is how poorly all the other nations are managing their economies, so the dollar continues to hold up.
Rich Comeau, Rich Investing
Rich Investing 