- Piper Sandler’s Michael Kantrowitz says investors will have a rude awakening in the second half of 2023.
- He said the rally so far this year has been driven by multiple economic expansions.
- But Kantrowitz says long-term profit expectations aren’t rosy.
Investors continue to welcome signs of a soft landing for the US economy.
Job gains remain strong, with the US adding more than 200,000 jobs in June. Inflation fell sharply, hitting 3% in June compared to the same month last year, a benchmark for the Federal Reserve’s 2% target. And the S&P 500 index is up 2.7% this week, up nearly 18% since the start of the year.
But the market is ahead of its time, argues Piper Sandler chief strategist Michael Kantrowitz.
Kantrowitz noted in a recent slide deck presentation that investors are pricing in risk as inflation falls. This led to a resurgence in price multiples, or valuations, driving the S&P 500 up.
Piper Sandler
What’s the problem with that? Future earnings forecasts have not caught up, but they suggest the fundamentals will eventually catch up with investors.
In addition, lower inflation means less pricing power and therefore lower earnings growth, Kantrowitz said.
Piper Sandler
“The current increase in multiples is not because earnings expectations are actually going up. “When you look at the earnings growth, we’re close to record lows. We would argue that it is based on the idea that,” Kantrowitz said.
The chart Kantrowitz mentioned is below. Long-term growth expectations, shown in gray, are near record lows.
Piper Sandler
The combination of low earnings growth expectations and high price-to-earnings ratio means the stock is more overvalued than it was during both the dot-com bubble and the Great Financial Crisis, based on price-to-earnings ratio and growth ratio. PEG ratio. PEG ratios consider long-term future earnings as opposed to more current-based price/earnings ratios.
Piper Sandler
“When you get earnings projections that have extremely high multiples and extremely low five-year growth rates, the PEG ratio is very, ridiculously high. So I look at this chart and what does it mean? I can’t help but think of a clear message: ‘Send us,’ Kantrowitz said.
He added, “In every sense, PEG ratios have never been this high in a normalized context.”
Kantrowitz’s base case is that a recession will hit the U.S. economy in the second half of the year, with leading indicators such as the ISM manufacturing PMI index contracting for months, reflecting softening demand. He urged investors to pay attention.
His official year-end price target is $3,225 on the S&P 500, down 28% from its current level of about $4,500. But he told insiders in an email on Friday that the index is unlikely to drop that much right now, given its massive gains in the first six months of the year.
“Given the strength of the first half, we consider it unlikely that we will achieve the targets we set out in January by the end of the year. “We still believe that we will continue to see the impact, especially on earnings and labor force, which will lead to negative earnings in the second half,” he wrote.
waiting for recession
The traditional signs that the U.S. economy is headed for recession are written all over the walls.
In addition to weak manufacturing activity, the U.S. Treasury yield curve remains deeply inverted, banks are less willing to lend to both consumers and businesses, and job cuts are on the rise.
But for the time being, the economy is still holding up, and the bulls are starting to mock the bears and their bleak outlook.
Like Kantrowitz, economist David Rosenberg urged investors to keep in mind that hawkish monetary policy is still affecting the economy.
In a recent note to clients, Rosenberg said, “It often takes a year or two for a Fed-induced yield inversion to become apparent, and even if it does, no one knows it and is prepared. Very few people do,” he said. “When the formal recession began in July 1990, March 2001 and December 2007, everyone had the same question and the consensus was either Goldilocks or a ‘soft landing’. “
Albert Edwards, a strategist at Societe Generale, also reiterated last week that despite how long calls for a recession have been proven false this year, a recession is on the way.
“Economists clearly get the recession wrong, but they always give up on it just before it hits. Yes, I remember that.” me too“I’m a super bearish person, and as I entered 2007, I found myself questioning my own recession predictions,” Edwards said, adding, “But I’ve seen this show before. It’s there and it’s still not shaking,” he said.
The data will tell if we will have a recession in the coming months, as Kantrowitz, Edwards and Rosenberg believe it will. But even if that isn’t the case, as Kantrowitz warns, weak growth prospects and already high multiples could mean a weaker stock market performance in the second half of the year.
