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Barclays outlined the top questions investors are asking as the S&P 500 remains stuck in a tight trading range.
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“What would be the likely turning point for the market to break the high or low?” In the midst of interrogation.
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Stocks look more likely to move lower in the short term, it said.
With large-cap US stocks inevitably falling and the Federal Reserve seemingly at a policy crossroads, what’s next for the $40 trillion equity market?
Barclays addressed five questions asked by clients in a note on Tuesday as the S&P 500 continued to move rangebound through the middle of the first quarter.
However, stocks have been trending lower since last week after the Fed delivered its 10th consecutive rate hike in its fight against inflation. Policymakers signaled a possible pause at their June meeting but also projected a tightening bias and indicated they could raise rates if warranted, Barclays head of US equity strategy Venu Krishna said in a note published on Tuesday. Wrote the note to the customers.
Krishna said the S&P 500 is likely to remain range bound in the near term. “However, beyond the short term, we think the risk/reward for equities is asymmetric – there is limited upside but more downside.”
Here are the 5 questions investors are asking:
1) What would be the likely turning point for the market to break the high or low?
The “unknowns” that have the potential to drive the direction of travel fall into three overall categories: 1) some “breaking,” or tail event; 2) the downward revision cycle, and 3) the Fed’s functioning.
Krishna said it is difficult to predict the probability associated with a given tail risk, but the market has handled several past risk events with “remarkable restraint”. Those risks include an outbreak of COVID, resulting in the stock recovering earlier than anticipated from the bear market.
“What this tells us is that the situation and responsible policy makers make it impossible for a tail event (absent a true liquidity crisis) to substantially derail equity values and lower the market,” he said. .
Tail risks aside, markets can be lulled into thinking headwinds — just like the current earnings slump — can be cleared in record time.
“We think it is too early to call on a FY23 bottom line, given that earnings growth is still negative and results have been a mixed bag below the headline beat,” Krishna said. “Earning trough is a reasonable catalyst for the market to break higher but we don’t think we are there yet given the deteriorating macro backdrop.”
2) When is the Fed likely to start cutting and how will equity markets react?
Financial markets appear to be pricing in the unlikely scenario of a recession that pulls inflation down sharply and keeps rates low while corporate earnings are relatively underwhelming.
“The only outcome in which we see the current rates curve accurate (Fed starts cutting in 2H23, accelerates in 2024) is the Fed responding to a fairly severe recession, which clearly bodes well for equities,” Krishna said. No,” Krishna said.
The baseline view from economists at Barclays is that the Fed leaves its key rate unchanged through the end of 2023 as the economy enters a mild recession in the second half of the year and upside inflation risks remain.
Barclays said, “Relative to the ‘2023 pivot’ scenario, we view the ‘long high’ outcome as the lesser of two evils.” This scenario tilts the balance of risk towards a shallow bearish base case and an S&P 500 price target of 3,725. The S&P 500 was at 4,125 during Tuesday’s session.
3) The buy side is probably close to our $200 EPS estimate, but if so why is the equity rallying?
“We think buyers are very keen to capture earnings while driving multiple expansions,” Krishna said. Mega-cap Internet stocks soared in price through first-quarter earnings, with companies offering a nod toward recovery in some sectors.
“While we are confident in another reset for the S&P 500 ’23 forward earnings, there is clear demand from sectors that may be closer to the bottom of the EPS revision cycle than others, enhanced by lopsided positioning “
The price-to-earnings ratio has come down from October’s low of around 15.5 times earnings to 18.5-20.5 times, the current consensus estimate for earnings per share from S&P 500 companies is $221. Barclays said its top-down valuation framework points to 18.5 times forward EPS as fair value when inflation recedes and economic growth recovers.
4) Why is the volatility of equities so low and what does it say about risk?
1) the income has been very low; 2) the consensus has done a better job of estimating the macro data print, and 3) the correlation has been low, it said.
“We caution against interpreting low equity volatility as a sure sign that we are out of the woods, as the macro fundamentals remain challenging,” Krishna said.
The stock market’s so-called fear gauge, the CBOE Volatility Index, stood at 17.39 during Tuesday’s session, slightly above this year’s low of 15 and its longer-term average of 20.
5) How do you deal with the current environment?
Thematic plays offer better risk/reward, Barclays said. It prefers large-cap stocks to small-cap, less-expensive quality names, stocks with high sensitivity to core services inflation, and US companies with revenue exposure to China.
The investment bank said, “The recent panic in the tech and financial sector has exposed individual sector risks in a late-cycle environment dominated by macro uncertainty and credit crunch, especially due to stagnant forward EPS wildly in valuations.” There are ups and downs.”
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