Oops. Stocks fell through a key support on Tuesday and it looks like some recent momentum has now petered out. The new line in the sand for the S&P 500 SPX, -1.44% seems to be 3,900. Whether Santa eventually comes or not is still to be determined, with Mr. Claus perhaps postponing a decision until next Tuesday’s CPI release.
But what’s clear is that the U.S. stock market is still in a bear market. And with that in mind, equity strategists at BNP Paribas mined 100 years of crashes to try to determine what’s next.
Strategists led by Greg Boutle, head of U.S. equity and derivatives strategy, are expecting a capitulation event next year. “This would be a departure from the current bear market regime, which has been characterized by a grind lower in equities as P/E multiples have contracted,” they say.
The most recent crash — the COVID-19 slump of March 2020 — is a bad template in their view, as it was driven both by the extreme nature of economic shutdowns and rapid monetary and fiscal responses. Nor do they expect 2008 to be the model, as they see U.S. GDP contracting about 1% next year, and earnings per share slipping 1.5%.
However, 2002 is quite representative of recessionary crashes. That bear market was more than two years in length, with a drawdown of 50%, and a 29 percentage point peak-to-trough move in the VIX VIX, +2.80%. A typical recession bear market is 1.5 years in length, with a median drawdown of 38% and a median peak in the VIX of 40.5.
“If we apply those averages to the market today, it implies a trough in the middle of next year, the S&P bottoming close to 3,000, and with the VIX in the low 40s,” they say.
The bull market that ended last year was similar to that of the 1990s, with high retail participation, massive P/E multiple price expansion and many of the top performers unprofitable. The S&P 500 troughed in 2002 with a price-to-equity ratio of 14. BNP’s 2024 EPS forecast of $231 implies 3,250 for the S&P 500 if the P-to-E multiple falls to 14.
In a neat bit of analysis, BNP recreated the VIX VIX, +2.80%, which CBOE introduced in 1993, to cover the last 100 years. Usually, volatility peaks at or before the market trough.
“We consider a capitulation as a move associated with a sense of panic that involves a rebasing of expectations, analysts aggressively cutting forecasts, volatility spiking and a repricing of tails. Over the last 100 years, the capitulations in volatility have on average come at the same time as the trough in the market,” they say.
What they do like in such a market? One idea is to find companies that have maintained stock buybacks through a slowdown. Another is to look at companies with earnings momentum, though the only sector identified with positive momentum in a related chart is utilities XLU, +0.62%. Tech is still vulnerable, though what it calls prime tech could outperform more speculative and cyclical parts of the sector.
After Tuesday’s slump, U.S. stock futures ES00, -0.21% NQ00, -0.43% edged lower. Oil futures CL.1, +1.09% fell, and the 10-year yield TMUBMUSD10Y, 3.477% was 3.54%. The inversion between the 2-year and the 10-year is now at levels last seen since the 1980s.
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