Market Perspective – Risk/reward less favorable as investors price in soft landing

Highlights

Markets have kicked off 2023 with solid gains. For perspective, though, the S&P 500 is just now back to where it traded prior to the December selloff.

With the easing in December’s sharp fund outflows alongside the calendar turning to January, which tends to be a reversal month, we have seen markets rebound with last year’s biggest losers bouncing back the hardest.

• In fact, the 50 worst-performing stocks of 2022 are up an average of 20.1% year-to-date while last year’s 50 best-performing stocks are up an average of only 1.9%.
• Remarkably, all 50 of last year’s worst performers are up in 2023, suggesting indiscriminate buying. We view this as most likely a short-term reversion of oversold stocks as opposed to new market leadership or a fundamental shift.

More broadly, the entire gains for the S&P 500 have been driven by expanding valuations, as analysts’ earnings estimates tick down to an 11-month low.

• While this is typical during the early stages of a new bull market, since prices tend to advance well before earnings and the economy turn up, we remain skeptical.
• We still see the likelihood of weaker economic trends later this year as the lagged impact of sharply higher rates weighs on the economy.

The S&P 500 is now trading at a forward P/E of 17.9x.

• Even using an optimistic assumption of an 18.5x P/E—the peak valuation level seen over the past decade outside of the pandemic—against current elevated consensus earnings estimates, would only bring the S&P 500 to 4200. This represents just 3% upside from the current level of 4071.