Market Multiples and Valuations – The S&P 500 is overpriced.

Last week, I had posted that high inflation and higher interest rates would cause stocks to fall and had suggested taking profits in stocks such as NVDA to buy back 20% lower. Now NVIDIA is pretty much a family jewel and selling some our holdings meant that I really foresaw a weak 2022 for the markets – even with the S&P down 8% from its all time high of 4,766 in Dec 2021!

Why do I think the S&P will fall further?

I don't believe the markets are fully pricing in

1. A 2.75% 10 year treasury rate and climbing – mortgage rates crossed 5%, that will hurt housing, one of the strongest spots in the economy.
2. 8% Y0Y inflation – many are divided, some think that's the peak, many portend that it could well increase further. I believe that a still very sluggish supply chain will continue to keep inflation elevated.
3. Geo political shocks from the war in Ukraine.
4. The Fed very much likely to increase interest rates in 1/2% bursts in 2022.
5. A profit squeeze due to higher costs, which will slow down earnings growth in 2022 and 2023 – this is very unlikely not priced in S&P 500 earnings.

There is an interesting S&P 500 earnings forecast from Yardeni research – here's the link https://www.yardeni.com/pub/yriearningsforecast.pdf

The market consensus for S&P 500 earnings are around 227 and Yardeni's is higher at 240.

At Thursday's S&P 500's close of 4,392 the 2022 PE is 18.3 for Yardeni's earnings and 19.5 for analysts' If you see the chart in figure 5, between 2007 and 2015, the PE ratio stayed below 15 most of the time and rarely rose above it. Between 2015 and pre covid March 2020, the PE ranged between 16 and 19, with a one massive drop to 13.5, mainly caused by the taper tantrum of late 2018 – when Fed chair, J Powell suggested he would start tapering and the markets took him to the woodshed. Post Covid, PE's were significantly higher for two reasons, lower earnings and an extra ordinary low interest rate and high fiscal stimulus environment.

Both have reversed in spades and the S&P is down only 8% ? And the forward PE is closer to 19, still at its high end of the range!

Bulls would argue that earnings have grown significantly, therefore higher PE's are justified. Sure they have but from lower Covid levels and a historically elevated profitable period due to huge stimulus and catching up of demand — which is highly unlikely to continue. Consensus earnings for the S&P 500 are calling for 10% growth in 2023 from 227 to 250, still above historical growth rates of 5.7% from 2009 to 2019. But, higher inflation reduces demand from consumers, which reduces earnings and higher interest rates reduce earnings multiples – a double whammy.

I would not buy anything till the S&P corrects to at least 4,000, another 9-10% fall from these levels.

2022-2023 are the years to play defense – hunker down and preserve capital. There will be a lot of opportunities for patient investors.