“Gordie Howe never took the elevator.”
-Dwight McMillan, Former Head Coach of the Weyburn Redwings
The quote at the start of the Early Look is from my former junior hockey coach Dwight McMillan. Before college hockey, I cut my teeth in the small Canadian outpost of Weyburn, Saskatchewan. Dwight was one of those old school coaches with high expectations and a no-frills approach to coaching.
Despite his quiet demeanor, he would go on to become the winningest coach in Canadian Junior Hockey history. That might not mean much to many of you, but four decades of coaching and more than 1,000 wins is big deal in any sport. It speaks to perseverance, discipline, and commitment.
After all of these years, I’m not sure why Dwight’s (or Dwighter as we called him) Gordie Howe quote resonated with me. But it did and it is a quote that pops into my head whenever I’m going through a rough spell. The translation is that the roads in life that are worth travelling typically involve some form of sacrifice. And to successfully traverse those challenging roads, you likely need to skip the elevator and take the stairs.
As stock market operators, we have learned this only too well over the last year or so. Back in the hey days of 2020 and 2021, making money was somewhat easy . . . you basically just had to be long of any risky, high beta asset class. In 2022, it’s not so easy as discipline and selectivity matter again.
Back to the Global Macro Grind…
None of us know for certain when this current market downturn will end. Nonetheless, every day on social media and in the mainstream media there is a new pundit ready to call the bottom and go all in. One rationale for calling the bottom is valuation. Earlier this week I read a thesis on Business Insider from Brian Belski, a strategist from BMO Capital Markets, that was titled, “Here Are 9 Reasons Stocks Could Be Primed for A Massive 4th Quarter Rally”.
In today’s missive, I thought I would provide some counterpoints to that thesis by countering some of Belski’s points (as a side note, I don’t know Brian and this isn’t a personal shot at all).
1. Stock Valuations Are Already Beaten Down
Stocks are certainly cheaper at ~16.4x forward P/E, but arguably they aren’t cheap versus longer run averages and the prevailing interest rate. In fact, over the last ten years the average forward P/E was a bit higher at 16.9, but the lowest level we’ve reached in that period was closer to 12.0x P/E back in 2012.
Also, if we look at other measures of valuation like Price / Sales and EV/ EBITDA, we are still very much at extreme valuation levels versus historical norms. In the Chart of the Day, we highlight Price/Sales, which normalizes for margins, and as you can see the current level of 2.2X Price / Sales is well above the low of 0.7X reached in 2009.
2. Earnings Estimates Have Fallen, But May Surprise In Q3
There is no doubt earnings estimates have fallen with Q3 estimates having declined by some -6.3% since the start of the quarter, but the question is whether they have come down enough and how will guidance look going forward. Currently, consensus estimates for Q3 2022 suggest +3.1% Y/Y growth and consensus estimates for Q4 2022 imply an acceleration in growth to +7.1% Y/Y growth. If you actually believe that earnings growth is going to re-accelerate into Q4, then I have a bridge to sell you in Stamford, CT because it is counter to almost all of the data we track on a daily basis.
3. Earnings Estimate Are Now Higher Than In Late 2021
Obviously, this is a backward-looking data point. As we know all too well, the stock market trades on future expectations. Now to be fair, the market is probably already pricing in some form of earnings decline into 2023. But how bad can it get?
Well according to some analysis we’ve done, which was validated by a paper from D.A. Davidson, earnings growth, or lack thereof, can get a lot worse. To wit:
“S&P 500 earnings per share (EPS) declines, from peak to trough, ranged from -4.6% in the 1980 recession, to -91.9% during the Global Financial Crisis (GFC) from 2007 to 2009. The average earnings decline across all ten recessions was -29.5%. That included two unusual events, as the GFC caused a collapse in the financial system and bank earnings, and the earnings decline in 2001 followed the bursting of the technology bubble, causing a massive earnings decline in that sector. Excluding those two periods, the average earnings decline during the other eight recessions was -18.7%.”
If we assume a 20% decline in SP500 earnings in 2023, that means we are currently trading at a P/E of roughly 20.5X . . . so not so cheap.
The point here isn’t to be overly critical of another strategist’s analysis, but rather to once again re-emphasize that valuation is an opinion. And based on that opinion, it is easy to conclude that despite recent stock market declines, stocks aren’t that cheap at all.
The reality remains bottoms are processes and not points. While the ride down this year has probably felt like a high-elevator to the bottom, the way up is likely to involve the stairs and take a fair bit of perseverance.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 3.54-4.01% (bullish)
UST 2yr Yield 4.01-4.37% (bullish)
High Yield (HYG) 69.91-73.77 (bearish)
SPX 3 (bearish)
NASDAQ 10,501-11,312 (bearish)
RUT 1 (bearish)
VIX 27.95-33.92 (bullish)
USD 109.85-114.93 (bullish)
Oil (WTI) 74.92-90.82 (neutral)
Gold 1 (bearish)
Bitcoin 18,578-20,667 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
