Green shoots in the stock market are visible (SP500)

In this article, we’ll review stock market valuation, the bond market, commodities, stock charts, market sentiment, and other factors to determine if we’re on the cusp of a new bull market for the S&P 500 (SP500).

evaluation

The stock market’s valuation is still above the average price it has earned in 70 years. Although the price-to-earnings drop from the valuation peak.

The forward rate-to-earnings for large S&P stocks is above 17, which historically hasn’t been the lowest in terms of valuation if one takes into account future growth prospects and interest rates.

The S&P 400 Mid Cap forward P/E is less than 14, an attractive valuation going back more than two decades.

The forward earnings price for S&P Small Cap shares is also at an attractive level of 13, which has been closer to the bottom since the late 1990s.

The forward P/E for S&P growth is below 18, while the P/E for S&P value is at 16. We’ve reached a point where growth stocks may become reasonably priced. The value of the shares is close to being fully priced in light of future growth in value-added dividends.

bond market

The bond market is always important, as it affects corporate earnings and its valuation since investments of any kind are based on the risk-free rate of government securities such as US Treasury bonds.

The tenth year is in an uptrend until it closes below 3.25%. A year ago, the 10-year Treasury was at 1.8%.

The two year is still in an uptrend until it closes below 3.5%. A year ago, the 10-year Treasury was less than 1%.

inverted yield curve

10 years minus 2 years reversed for months. The Federal Reserve bond market indicates that future economic growth is likely to be slower.

The US has been inverted by 10 years minus 3 months for more than a few weeks, which has been troubling in the past when combined with 10-year and 2-year inversions.

Economist Campbell Harvey showed in his dissertation that an inverted yield curve is relevant to economic activity, and he correctly identified upcoming recessions. He recently noted that 10 years of inflation-adjusted minus 3 months is far from reversible, and so he doesn’t think the US economy will necessarily experience a slowdown.

big company

High-yielding companies (HYG) have rebounded from their lows in October 2022, which means risk could return if HYG remains above 77.

Investment grade companies have also rebounded from their October 2022 lows; However, we need to see continually higher levels in the coming months.

US High Yield Index (Option Rate) Spread is less than 6.5. It’s falling and posting lower highs and lower lows, which is a positive for stocks.

Treasury and corporate bond ratio

The ratio of treasury bonds (IEF) to investment grade corporate bonds (LQD) helps determine the risk or risk aversion environment, as determined collectively by bond investors. Below is the IEF/LQD chart, which shows it is trending towards a supportive environment for equity investors.

goods

Lumber prices fell, mortgage rates went up and the housing market slowed sharply.

Natural gas futures are down below prices a year ago.

Crude oil prices are also slightly lower than they were a year ago.

Copper prices have rebounded from their lowest levels but are still lower than prices a year ago. Rising copper prices are associated with increased economic activity.

Future wheat prices are what they were a year ago.

Corn futures prices are higher than a year ago.

Silver prices have moved higher in the past few weeks and higher than prices a year ago. This may indicate an increase in economic activity.

Uranium prices are almost the same and have stabilized in the past few weeks.

Rental prices, as measured by Zillow, are falling; However, the rental component of the CPI has not started to decline. It will start declining in the coming months and is likely to show rapid subsidence inflation.

If goods, rents, and other components of inflation fall, inflation will continue to slow in the coming months, and the Fed should be able to end the Federal Funds Rate (FFR) increases.

US dollar index

The US Dollar Index (DXY) retreated after peaking at 114.8 and dropping to 102. The falling Dollar Index supports stocks and makes US exports more competitive.

green photography charts

S&P 500 chart is still in a downtrend until it breaks above 4110 and stays above 4050. For conservative investors, S&P 500 needs to close above 4350 and stay above cloud and 4050 on a weekly closing basis.

SP500 chart with 200-day moving average and 200-week moving average.

Estimates for commodities with equal weight are flat to the upside, and so far indicates that the stock market may be heading into a risky environment.

Higher yields have outperformed the SP500 from the October 2022 low, another positive green shoot.

The advanced decline line has breached the highs from August 2022, which is another green starting point.

The S&P 500 had a broad trend last week along with a number of other positive signs. All of these signals are piling up as support for the rise in stock prices.

New net highs on NYSE and NASDAQ turned positive, but they need to remain positive and make more new highs to confirm the upside.

The Dow Jones Transportation Average (DJT) is about to break above levels as of November 2022. It has remained supportive of the stock market in general.

The number of stocks in the S&P 500 above the 200-day moving average and the 50-day moving average shows broad participation in the index.

SPX stocks are above the 200 and 50 day moving averages (Author)

The US high-yield corporate bond index has risen steadily and is about to break through to new levels, indicating a risky environment.

Similarly, stocks are also supported by the VIX, which has fallen below 20.

VIX term structure

The term structure of the VIX is in contango and the VIX is less than 20. This is a positive and supportive development of the risk environment.

Feelings and positioning

Sentiment has remained bearish for a number of weeks. While I wouldn’t rely too much on sentiment, it could mean that a lot of investors are worried about a recession and are holding onto cash or shorting the stock market.

Positioning, as measured by the National Association of Active Investment Managers, shows low levels of long positions.

money market

There are over $5 trillion in money market funds. Any cash-to-stock allocation would drive the stock higher along with short covering.

marginal debt

Marginal debt has fallen to pre-pandemic levels, which is also supportive when the stock market starts an uptrend.

Stock market and earnings

The bottom of the stock market is ahead of the earnings as shown below. The stock market will take months or even a year before profits pick up or economic growth picks up. The stock market discounts nominal dividends well ahead of the economy.

economic indicators

Economic indicators are showing a slowdown in economic activity and it is now in contraction territory. Leading economic indicators are falling fast, as the Federal Reserve raised the federal funds rate at the highest rate the US economy has seen in decades.

The services PMI fell below 50 last month, raising the possibility of an economic slowdown in 2023.

The Manufacturing PMI has been below 50 for the past two months in a row.

Inflation is declining rapidly despite the fact that the rents component of the CPI has been lagging for months and still showing that rents are still increasing. In the coming months, both commodities and the delayed shelter component (the largest percentage of CPI) will put downward pressure on inflation. The annual consumer price index for the last 6 months is less than 2%.

Federal recession forecast

The Fed expects approximately 50% chance of a recession. In the past 60 years, the New York Federal Reserve model has been fairly good at predicting a recession.

summary

The economy is likely to slow down. However, the question remains whether the stock market has fully discounted earnings for next year and whether it is comfortable with the valuations. Even if there are green shoots, it is possible for the stock market to drop if unexpected news comes out, which has not already been priced in by the stock market. Last week’s inflation report continues to show a sharp decline in inflation. Earnings season has begun, and it will be instrumental in determining whether the stock market will move up or down, which will retest the lows from October 2022.

I won’t be impatient and will wait to see how stocks react to earnings. Although I would be willing to post new cash if earnings and guidance receive a positive reaction from the stock market.