U.S. stocks closed higher yesterday, with the Dow up 1.61%, the Nasdaq up 2.68%, and the S&P 500 up 1.99%. Zhitong Finance understands that bargain hunters have been returning to the market recently, in addition to a weaker dollar, less “hawkish” Fed rhetoric and good retailer performance, all boosting the stock market to some extent.

However, with the S&P 500 down nearly 15% so far this year, the Nasdaq down more than 12% and the Dow down more than 10%, combined with the recent gains, this seems to give the market a signal that stocks are no longer expensive. Analysts at Bloomberg expect the S&P 500 to earn $248 a share next year, or a forward price-to-earnings ratio of 16. While not cheap, the valuation may be fair. Is the reality really that optimistic?

Analysts at Goldman Sachs and JPMorgan Chase believe the sell-off has gone too far, with recent price action overestimating the likelihood of a recession. At the same time, Credit Suisse Group also believes that if U.S. bond yields peak, U.S. stock markets may rebound quickly.

In fact, behind every forecast from analysts is the belief that valuations have explained all the pain the economy and earnings could suffer . But the above calculations are based on forecast earnings, and their reliability is more dubious, especially with the Fed raising rates. Analysts have long turned a blind eye to downturn options. A classic example in history is early 2008, on the eve of the global financial crisis, when the market expected S&P 500 profits to rise by 15%.

In addition, using historical P/E ratios as a signal that the market has bottomed is risky. With inflation raging and the Federal Reserve pledging aggressive policy tightening, stock market valuations are at one of the most unfavorable times in decades. In a bear market, stocks rarely stop falling at the average price-to-earnings ratio, and rallies like this week’s are more of a signal that the market is about to face a bigger drop.

Giorgio Caputo, senior fund manager at Hambro Capital Management, said: “It is dangerous to rely too much on expected returns. We are dealing with a wide variety of economic outcomes, and if we do enter a recession of some kind, expected returns are likely to be missed. Not a big drop.”

History has countless examples of stocks that appear to be undervalued relative to expected earnings, but are not. Since World War II, corporate earnings have tended to fall by 13% before and after economic contractions, according to data compiled by Goldman Sachs strategists led by David Kostin.

Of course, it is nearly impossible to pinpoint the apex of a growth cycle. But to illustrate the point, assume the U.S. public company can achieve its expected earnings for the year: $227 a share. Then assume that a recession hits and corporate profits shrink by 13% by 2023 (a typical economic contraction), in which case S&P 500 earnings per share would be $198, not analysts The current estimate is $248. Meanwhile, the stock will trade at 21 times earnings instead of the 16 times that seems reasonable.

“We don’t think these multiples are sustainable and expected earnings have to come down,” said Alicia Levine, head of equity and capital markets advisors at BNY Mellon Wealth Management.

What is an appropriate valuation for a stock?

In an environment of Fed rate hikes, the Fed model may be able to answer that question. It is understood that this model is a valuation method issued by the Federal Reserve, and it is also an internationally recognized price-earnings ratio valuation method. Treasury bonds), the model signals whether to buy or sell stocks based on bond yields.

As shown in Figure 3, compared with the historical level of the post-crisis bull market, the current stock valuation is still high, but if the time dimension is extended, the current stock valuation is quite cheap. While first-quarter earnings continued to beat estimates, there are signs that analysts’ expectations for 9% annual growth over the next two years may be too optimistic.

Nicholas Colas, co-founder of data research firm DataTrek Research, said that a huge threat to the market actually comes from the Federal Reserve. The reason is that the Fed has taken steps to push down stock prices and corporate earnings to ease wage pressures and consumer demand in an effort to combat the highest level of inflation in 40 years.

As a result, Colas doesn’t see a bottom until the S&P 500 hits 3,500, a 27% drop from its January peak.

This article is reprinted from: https://news.futunn.com/post/15930851?src=3&report_type=market&report_id=206752&futusource=news_headline_list
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