Market-Cap Weighted S&P 500 Breaks Out; Have We Already Seen the Bottom?
publication date: Jan 26, 2023
author/source: Brian Nelson, CFA
Image: The market-cap weighted S&P 500 (SPY) has broken through its downtrend. The markets could be headed meaningfully higher. Image Source: TradingView
By Brian Nelson CFA
Excess savings in consumer bank accounts from the pandemic stimulus and government intervention that was issued during the worst of the COVID-19 pandemic will start to deplete almost entirely by the middle of this year. Talk of the debt ceiling on the U.S.’s national debt of $31.5 trillion is emerging, and interest on the debt will start to crowd out other spending with respect to the national budget.
The markets, however, are forward looking, and many of these concerns are largely “baked in.” Within the discounted cash-flow model, for example, we take into consideration the nature of the economic cycle and generally target mid-cycle expectations on a run-rate, going-concern basis, so a looming recession, in simplistic sense, should not have too large of an impact on intrinsic value estimates across our coverage.
We’re not saying that a weakening consumer, looming economic weakness and rising interest rates on the national debt won’t impact the markets, but such an dynamic within the discounted cash-flow (DCF) model should be relatively modest (as most value is generated by mid-cycle long-run considerations). The Fed’s rate hikes have already driven the discount rate within the market implied DCF higher, but inflation may have already peaked in June 2022, and many expect the pace of inflation to fall rapidly as 2023 progresses.
From my experience, the markets generally look (discount) roughly two to three quarters ahead, and what the charts are telling me is that inflation has peaked, the economy might bottom later this year, and that earnings growth will resume in earnest in 2024. The Invesco S&P 500 Equal Weight ETF (RSP) broke out recently and now the market-cap weighted S&P 500 Sector SPDR (SPY) has broken out. The technical downtrend that has been broken through defined almost all of 2022, and the path of least resistance now seems higher, in our view. The next few weeks, however, will be telling whether markets will sustain the breakout with a strong technical follow through.
Fourth-quarter 2022 earnings season is in full swing, and reports haven’t been that bad. Aside from Goldman Sachs’ (GS) fourth-quarter report, there haven’t been many big misses this quarter. S&P 500 earnings are expected to contract about ~5% during the fourth quarter of 2022, and while the outlooks for reporting companies such as Microsoft (MSFT) have been conservative heading into 2023, so far things are much better-than-feared, in our view. The forward 12-month P/E ratio for the S&P 500 stands at 17x, according to FactSet, which is below both the 5- and 10-year averages of 18.5x and 17.2x, respectively.
Here are some key developments during fourth-quarter 2022 earnings season thus far.
The market-cap weighted S&P 500 has broken out of the technical downtrend that defined 2022 following the equal-weight breakout that preceded it. The pace of inflation looks like it peaked in June 2022, and while myriad risks to both the economy and stock market remain, fourth-quarter 2022 earnings season is shaping up better than feared. We maintain our view that the markets remain at critical technical levels, and we continue to monitor earnings season and technical developments closely.
Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, RSP, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE, DIA, and RSP. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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