Rearview to Windshield, January 2023

by | Jan 3, 2023 | Blog, Market Updates

December 2022 Market Recap: There was no “Santa Claus” rally in December – more of a “Santa Snooze” – as the market traded effectively sideways the last 2 weeks to finish the year at ~3840 on the S&P 500, near the midpoint of the ~3500-4200 range we have been saddled with since April, and all major core indexes below 50- and 200-DMAs.

In the final 2 weeks, the 10-year Treasury yield spiked higher to ~3.88% from a low of ~3.4% two weeks ago (we suspect mostly due to Japan’s move to increase yields), but volume was low across bonds and equities. Since 1928, the S&P 500 has only posted back-to-back negative years on 4 previous occasions (1929-1933, 1939-1941, 1973-1974, and 2000-2002). 

 

 

Large Tech Pain: The Big Tech cohort (AAPL, MSFT, GOOG, AMZN, TSLA, META & NVDA) has collectively shed ~$4.7 trillion of market cap during the course of ‘22 – for comparison sake, that amount lost is larger than the current market cap of nearly every S&P GICS sector (Info Tech and Health Care the exceptions) — poetically, this ~$4.7trn figure roughly matches the amount of value lost by the entire Nasdaq Composite back in the dotcom bubble (~$4.6 trillion of Nasdaq Composite market cap lost peak to trough). 

Value v. Growth: From a performance standpoint large-cap growth had one of its worst years relative to large-cap value since 2001, when the dot-com bubble was imploding in real-time. With that said, the Russell 1000 growth index underperformed the Russell 1000 value index by 21.6% in ‘22. The perceived higher margin of safety embedded in lower multiple value shares and a lesser reliance on capital markets to fund their ongoing operations has been favored by investors more broadly, relative to their long duration growth counterparts. 

Small v. Large: Generally small-cap indexes outperformed large-cap core indexes in ‘22, which may seem unusual to those moving into large-cap U.S. equities as a bastion of safety, but alas, valuation clearly matters, with the S&P 500 entering the year at >20x, while small-cap indexes entered the year at low teens P/Es.

Recent GDP Readings: After two consecutive quarters of decline, US GDP rebounded sharply at an annualized 3.2% in the third quarter, but the snapback resulted from a dramatic swing in trade, inventories, and government spending. Indeed, trade boosted GDP growth by 2.8%, reflecting strong exports – which was a weakness in the previous reports. GDP excluding inventories, trade, and government spending has steadily lost steam since the start of this year, coming in at just 0.08% in Q3. This shows that the nominal economy remains strong 

No Help from Bond Markets: In December, bonds continued to be correlated with equities. The pain in the bond markets continued in December, with the U.S. Aggregate Index down almost 13.0% for the year. Since the late 1970s, no other year has come close to experiencing similar pain in the bond market. U.S. bonds are now 18.4% off their peak in July ‘20. Except for the drawdown that ended in February 1980 (when the index was only calculated monthly), this is almost twice as large as the next biggest drawdown on record. 

Don’t Expect a Pivot Just Yet: We continue to believe that the Fed Put is much lower right now, as FOMC Chairman Jerome Powell, has stated that the Fed is going to keep raising until we have a recession unless inflation meaningfully improves. The cause of the decline is also important. The Fed has a long history of easing policy in response to earnings drops, but there isn’t much evidence that it responds to multiple compression. The fact that inflation is higher than at any time since the genesis of the Fed Put and that stocks have appreciated a lot over the past two years suggest the strike is well below current prices. Similarly, the recent decline in stock prices owes exclusively to lower multiples; it would take another leg down induced by a drop in earnings to impress the Fed.

Earnings Continue to Recede: Earnings likely to play an increasingly bigger role from a directional standpoint as the market transitioned from inflation to growth frustration. We believe that consensus estimates still need to come down to reflect a softening macro backdrop and inflation/margin pressures. We remain skeptics that the current 2023 earnings expectations for the S&P 500 remain too high. On average, earnings, as a whole, tend to fall between 15% – 20%, of which, earnings are 9.1% off their highs. 

S&P Valuation: The S&P 500 valuation decreased over the month, as the market declined 5.8%, which trumped the 1% decrease in earnings expectations. The market trades at 17.2x (18.2x last month). 

Earnings: ‘22 S&P 500 op. earnings = $221 (+8.3%). 2023 = $231 (+4.5%). 2021 = $204. 2020 = $136. 2019 = $161. *

Valuations: S&P 500 Fwd. P/E: 17.2x, EAFE: 11.9x, EM: 10.7x, R1V: 14.0x, R1G: 22.0x, and R2K: 11.5x. *

*Source: Bloomberg and FactSet, Data as of 12/31/22

 

 

 

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