Stocks are emphatically on sale, but are they cheap? Markdowns are not always the same as bargains. Much depends on the original price and quality of the goods. And even with last week’s price drops on Wall Street, it’s tough to say yet that the market is broadly cheap. But value seems to be emerging in some corners of the market, possibly rewarding the hunt for good deals as part of the “Everything must go” clearance event of the past several weeks. The speed, depth and breadth of the price declines after last week’s 5.8% loss in the S & P 500 taking its overall decline to almost 24% has created rare extremes in selling persistence and oversold readings. A week ago, this column asked if market conditions had gotten “so bad it’s good” based on the likelihood of a reversal, concluding things were “probably not quite there in a comprehensive way.” But now, by a variety of measures, we’re very close, making a meaningful bounce more likely very soon. Washed out The percentage of S & P 500 stocks trading above their respective 50-day average heading into Friday’s session was essentially as low as it gets, comparable to readings from significant market lows going back 20 years. Importantly, the comparable tally of stocks above their 200-day average is not yet at such “extreme extremes,” because of the speed of this decline. And broader gauges of downside momentum are getting stretched but have room to fall further. The pain has been widespread enough that fewer than a quarter of index members are still within 20% of their 52-week high. As the chart from Thrasher Analytics shows, this got worse in the Covid crash – a five-week, 35% collapse – as well as in the 2007-2009 financial-crisis bear market, an 18-month assault that took the market at one point to a 12-year low. A lot of the damage-assessment studies look like this now, showing the market unusually washed out by typical standards, the kind of setup that is a clear buy in an up-trending market, but is less reliable in aggressive downtrends like in 2000-2002 and 2008-’09, multi-year retreats coinciding with sharp recessions and featuring successive waves of corporate distress. Buying opportunity near? As share prices fall, forward potential returns, by definition, go up, which promises nothing about the timing or the path but big declines start to stack odds in a buyer’s favor. Market technician Jonathan Harrier ( @jonathanharrier on Twitter) points out that on Thursday 42% of S & P 500 stocks hit a new 52-week low, only the tenth time since 1985 this total exceeded 40%. In every one of the prior instances (most of which were in 2008 and 2020), there was generally further downside — an average of 7.6% over the next month, for example — yet forward returns were a good deal better than average in ensuing months. Yet last week might have been a short-term crescendo of catalysts. From Friday the 10 th , the tape absorbed a too-hot CPI report, a leaked intention by the Federal Reserve to lift short-term rates 0.75 percentage points rather than the expected 0.5, the eventual three-quarter-point hike and hawkish talk from Chair Jerome Powell, all leading to one of the heaviest quarterly options and futures expirations ever seen on Friday. What’s always been a narrow, rocky path to a possible soft economic landing was almost universally cast as even more treacherous and unlikely after the Fed essentially admitted it would have to soften up demand and employment quite a bit until inflation expectations (mostly a proxy for gasoline prices) retreat convincingly. Yet if you squint, could it be that it was also a short-term peak in stagflation panic? Crude oil fell 10% and big-cap energy stocks dropped 17% on the week, copper and agricultural commodities are rolling over, and the two-year Treasury yield pulled back hard, finishing below where it sat the moment before the headlines hit of the Fed’s decision to do a supersized rate hike. The market limps away from the week battle-scarred and war-weary, yes, but also more battle-tested, and emerging with cleaner investor positioning (Morgan Stanley says long-short hedge funds’ equity exposure last week hit the lowest level since April 2009, right after the system nearly imploded). Making these judgments is tricky, and the week after June expiration – this coming week – has been consistently negative in recent decades, down 25 of the last 32 years. Tough to know how relevant after a down-5.8% expiration week; last year June expiration week was down 1.9% and the following week the S & P gained 2.7%. Getting toward month-end should bring appreciable portfolio rebalancing back into equities after their massive underperformance against bonds this quarter and month. Are stocks cheap? Getting beyond the technical tea leaves and market rhythms and back to the question of whether lower prices mean good value, here’s where the S & P 500 forward price/earnings ratio is currently. A P/E a bit under 16, well off the pre-Covid high and not far above where it has bottomed in prior severe sell-offs in 2016, 2018 and 2020 closer to 14-times. On a long-term basis, this is essentially fair value rather than cheap. Various models incorporating interest rates and inflation might render it on the high end of fair, so perhaps investors would be lucky if the damage halted around here, as if a pendulum stopping partway through its swing. Many will say this evaluation depends on the reliability of the earnings forecasts, which have largely held up and most see as likely to decline. This makes intuitive sense, but all the prior valuation lows also came at times when the profit picture was in serious doubt — which is why valuations were collapsing in the first place. In any case, S & P earnings estimates outside of energy are already falling for the second through fourth quarters, says Barclays, sliding 3 percentage points in recent months. Stocks resilience to further erosion here will be another test. Away from the marquee index, things look a good deal cheaper. The equal-weight S & P 500 finished the week at 13.1-times forward earnings; it bottomed in December 2018 at 12.9 and in March 2020 at 11. Smaller stocks are far more clearly getting cheap (and/or signaling a nasty profit plunge), with the S & P Small Cap 600 scraping 10-times earnings, a few blips above the March 2020 trough. Selected blue chips are certainly starting to emerge in valuation screens, too. JPMorgan Chase , not far above 9-times expected profits, is almost down to the P/E it reached as CEO Jamie Dimon bought shares in February 2016 to help put in a low for a brutal multi-month correction. Best Buy under an 8 P/E and with a 5% dividend yield seems to be discounting scary things for the consumer. Maybe this is justified given the way consumers overdid it with durable goods since 2020 and a dicey retail future; value traps, after all, are a genuine hazard of buying cheap. But for anyone thinking the economy can be more resilient than now feared, the bargain bins are starting to fill up.
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