- According to Raymond James, the 42% drop in the S&P 500’s price-earnings multiple is the biggest drop in nearly 50 years.
- The investment firm said falling interest rates and moderating inflation will help fuel a rebound in valuation multiples this year.
- Here are five reasons valuations are poised to rebound, according to Raymond James.
The stock market is poised for a rebound in its valuation multiple and indeed share prices this year as inflation and interest rates begin to moderate, according to Raymond James.
That’s good news for investors who have been sitting on big losses after last year’s nearly 20% plunge in the S&P 500. A large part of that loss was due to a reassessment of valuation across different sectors of the market. stocks, mainly technology, as investors adjusted to multi-year highs in short-term interest rates.
If investors can earn a risk-free 4% return on short-term bonds, why should they risk their hard-earned money on stocks that have only gone down? At least, that was the thinking for much of the past year.
According to Raymond James chief investment officer Larry Adam, the S&P 500’s price-earnings multiple has plunged 42% in the past two years, making it the biggest two-year drop in nearly 50 years. That valuation drop even exceeds the drop seen during the great recession between 2007 and 2008.
Adam is turning more bullish on the market as he expects the S&P 500 to end the year at 4400, which is a potential 10% upside from current levels. But with his view that earnings will decline this year, Adam expects much of the upside to come from a positive reassessment in stock valuations after falling too far last year.
Here are the five reasons why stock market valuations are poised for a rally in 2023, according to Raymond James.
1. Consecutive falls in valuations are rare
“Last year’s stock market crash marked the second straight year of P/E contraction… The good news is that three straight years of P/E contraction is an outlier for the S&P 500, in that it has occurred only once in the last 30 years (1992-1994),” Adam said.
2. Valuations and earnings don’t bottom out at the same time
“The P/E multiple typically contracts at the start of a recession, bottoms out soon after, and then expands rapidly despite difficulties for earnings growth.* Why? The market is a forward-looking mechanism, so As the P/E multiple begins to anticipate the recession coming to an end and the eventual healthy rebound in earnings, if that holds, around mid-year, the multiple could begin to expand and support a rally in the equity market. values,” Adam said.
3. Lower interest rates are optimistic
“We anticipate the 10-year Treasury yield to fall to 3% by the end of 2023. Historically, lower interest rates have led to higher P/E multiples, as lower rates push investors higher in the risk spectrum in search of higher yields… As the 10yr Treasury yield falls to ~3%, a multiple in the 20-21x range is not only quite feasible, but falls in the line of trend”.
4. Lower inflation is bullish
“Our forecast is that headline inflation will moderate to less than 3% year-over-year by the end of the year. Now, where is the P/E multiple historically at this level of inflation? Since 1960, when year-on-year inflation It has ranged from 1-3%, it has coincided with an average P/E of 20x,” Adam said.
5. Valuations tend to bottom out near the latest Fed rate hike
“We forecast the Fed will only implement two additional rate hikes, the last at the March FOMC meeting. This timing of the final hike is important from a multiple perspective, as the multiple has historically bottomed out coinciding with the final hike. from the Fed and then expanded 7-8% over the next 12 months, on average,” Adam said.