Keeping up with the news flow since the Rose Garden tariff announcements last Wednesday evening has been an exercise in futility for this podcast, but not our written research. In today’s edition of the podcast, we wanted to highlight some of the more important things we’ve written about over the past few days that we wanted to make sure our podcast listeners don’t miss.
The big things you need to know:
EPS forecast for:
• Second, as the stock market has continued to gap down, we’ve continued to highlight our tiers of fear framework for how far US equities could decline in different scenarios.
• Third, our weekly valuation and flows updates provided us with some insight into why US equity markets have been gapping down so severely.
If you’d like to hear more, here’s another five minutes.
Now, let’s jump into the details.
, and also cut our YE:
• This is the second time we’ve cut both forecasts this year. On March 17th, we lowered our EPS number to $264 from $271, and our price target to 6,200 from 6,600.
• Our new EPS forecast bakes in real annual GDP growth of half a percent this year, inflation in the upper 3’s, a few cuts from the Fed, and margin contraction. These are all worse assumptions that our prior forecast, which was looking at 1.6% GDP, inflation in the upper 2’s, no Fed cuts, and flat margins. It’s a stagflationary set of assumptions, but not a recession scenario.
• Our price target, as always, is close to the average output of five different quantitative models.
y – down around the GFC and:
• Most of our other models are much more downbeat. On the policy side, we’re no longer baking in business-friendly vibes, or the typical market return when Republicans control the White House, the Senate, and the House. Now, we’re baking the 6% annual decline of 2018, when the stock market also grappled with frothy sentiment and positioning to start the year, Trump’s first trade war, and policy error – back then from the Fed. That suggests the index ends the year at 5,515.
• Meanwhile, our GDP test bakes in the typical decline when GDP ends up in the 0-1% range, which is a drop of 17%. That suggests the index ends the year at 4,876.
x or:
• As always, we view our price target as a compass, not a GPS, and a signaling mechanism for the path we see the stock market on. We think enough damage has been done to knock the market off its constructive path. We do plan to keep revising our models if and when new information comes to light.
Moving on to Takeaway #2: our tiers of fear is a good thing to keep handy as stocks continue to gap down.
• Our price target change on Friday morning was a well telegraphed move. Throughout March, we’d been telling investors that the risk we’d have to pivot away from our base case (originally 6,600, then cut to 6,200) and over to our bear case (which we originally set at 5,700, then revised down to 5,550 on March 17th) was growing. We indicated that for our base case to pan out, the drawdown since the February peak would need to be contained at 10%, and that if we broke significantly below that, our bear case was a more reasonable way to think about where the S&P 500 could end up at the end of the year.
• Unfortunately on Thursday, we broke through that 10% threshold decisively, triggering our decision to downgrade our view of where the S&P 500 would be at year end.
• So, what was so important about 10%?
• Our tiers of fear framework maps out what drawdowns have looked like in the US equity market in recent decades.
• Tier one is a garden variety pullback, of a 5-10% drop. That held before the rose garden, and fell apart immediately after.
with the average drawdown of:
• What if we break those levels? Look to Tier 3, a recession. There, the median and average drawdowns have been 27% and 32%, which would take the S&P 500 into the 4,200-4,500 range. We see the risks of this scenario growing, but it’s not our base case right now.
• Tier 4 is a major crisis like the Tech bubble or GFC. There aren’t a lot of those in our sample. The S&P 500 fell 49% during the Tech bubble and 57% during the GFC. If you keep it simple and say 50%, that takes us to 3,100 on the S&P 500.
Wrapping up with Takeaway #3: a few clues from our valuation and flows analysis.
• We were tempted to skip our weekly updates on Friday, but were glad we went ahead as we learned a few helpful things.
• First, on valuations… if we pretend for a minute that earnings forecasts don’t need to come down, which we absolutely know isn’t true, the S&P 500 still doesn’t look cheap. The various gauges of forward P/E multiples that we’ve been tracking are still well above average.
• Nasdaq 100 P/E’s have gotten close to average.
re progress, with the Russell:
• And finally, on flows…. The weekly EPFR data – which didn’t capture Thursday or Friday inputs - has nevertheless now highlighted two consecutive weekly outflows for US equities, with weakness seen now in Large Caps, and Large Cap passive in particular.
• Meanwhile, the inflows we’d been seeing to Europe and Germany are decelerating. A few weeks ago, US equities were under pressure due to geographical rotation. Even before the Rose Garden announcement, there were signs that outright derisking had started up.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.
