Barring a huge rally Friday, this will be the sixth consecutive week of stock market losses. That doesn’t happen often. As I mentioned last week, we’ve been sniffing around markets looking for value.
At the beginning of the year, the S&P 500 forward P/E was close to 22x or a 30% premium to fair value. This valuation premium combined with our view of weakening economic growth led us to our underweight equity allocation. After quite the decline year-to-date, US Large Cap stocks are trading around fair value. It has been a long time since we could say that. The S&P 500 is now trading at 17.3x 2022 estimated eps vs its historical average forward P/E ratio of 16.7x. Analysts have increased their full year earnings estimate to 228. We would estimate a range of 200-230 eps for the S&P 500 this year, so fair value is in the range of 3,400-3,900. The low-end accounting for a recession and the high-end pricing in decent year over year earnings growth.
In addition to the price decline in the stock market, investor sentiment has been terrible. Thursday’s Fear & Greed Index hit a new low for the year.
The last two weeks have had investors running for the exits. We’ve heard rumors of several large hedge funds hitting margin calls and having to liquidate.
Total positioning is very light relative to the last year. This means that institutions and retail investors have sold down their equity exposure.
So basically, we now have a stock market that is at the top end of fair value combined with investor panic. Those two conditions historically have been buy signals for long-term investors. We have no idea how much more selling is left in equity markets in the short-term, but we are getting more uncomfortable with our underweight equity positioning. We are going to start slowly adding stock exposure to the portfolios. If the market continues to decline—assuming no significant change to the economic outlook—we will get more bullish. We might be too early with this change of direction, but we aren’t trying to time the market in the short-term. Our process is about investing in assets that have the right balance of risk and reward over the long-term.
