Market Forecast For the Week of January 17, 2023: The Bulls Are Betting Bold While The Fed Urges Caution

FORECAST: The S&P consolidates early in the week below its bear market trendline in the 4000 region before heading higher in yet another leg of this bear market rally. Lower interest rates and a weak $US are fueling a nervous bullishness that awaits fourth quarter earnings with vapid hope. Most likely earnings come in just below expectations and paradoxically send equities higher as further proof that the economy is slowing enough for the Fed to pivot to eventually cutting rates. This implausible scenario is made worse with the drop in long-term interest rates and the falling $US, and it remains a matter of time before investors see the deteriorating quality of earnings and decide that a recession in profits if not in employment warrants low valuations and a continuation of vicious bear market that began a year ago.

The key issue distinguishing the bulls from bears is the forecast of S&P 500 earnings and the associated valuation multiple. In the past 2 months estimates for 2023 earnings have declined modestly, in line with the negative tilt of corporations during the 3rd quarter, where not only were earnings and revenues mild but the quality of earnings was on average deteriorating. Currently analysts expect 2023 earnings of around 4% for the S&P 500, and my analysis of the earnings for the top 100 firms yields an expectation of nearly 7%. Since the Fed has repeatedly warned of pain to come as they engineer higher rates the idea that earnings will growth faster than current inflation levels is bold. Since the index is market-cap dominated investors are essentially betting that the largest firms are immune to a recession that will plague lesser firms.

More striking is the multiple, as less than half of the top 100 firms in the index are undervalued relative to 2023 earnings. And that reflects the high multiples assigned to firms over the past 10 years, which were a period of near-zero interest rates. If one assigns a normal multiple of 15-16 times earnings then few stocks are undervalued and these are concentrated in financials and energy firms. In a macro environment of rising rates it’s bold to even bet on these sectors, let alone cyclicals and growth stocks.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the ETF SPXU, all of which nets out to a large short position in equities.