The 2022 bear market needs to move further based on historical trends and valuations of interest rates. The 2022 S&P 500 continues to track the bear markets of 1937, 2000 and 2008. The flow of humanity over past and future events.
The mid-August peak marked another tipping point for the S&P 500, leading to new lows in September. At this point, historical references to past great bear markets suggest another low is coming around October 25th.
New lows for October?
In terms of events that could continue the decline and bottom out at the end of October, a better earnings season than feared could be one such event. It remains to be seen if the late October low will be the bottom or the short-term low, but given how high valuations are, more work needs to be done to close the bottom.
price is everything
The S&P 500 2022 earnings yield minus the 10-year real yield is currently 4.56%. Historically, this is at the lower end of the range, associated with the top of the market rather than the bottom of the market. For example, 4.5% of the regions were visited in December 2016, January 2018, October 2018 and June 2020. The only time we didn’t see a significant drop was in December 2016, when the index was flat for nearly three months.
Since 2014, the average spread between the S&P 500’s current-year earnings yield and 10-year real yield has been around 5.2%, with standard deviations ranging from 4.87% to 5.57%. The premium to the S&P 500 10-year TIP is now more than two standard deviations from the average. The spread would need to increase by 30 bps to bring the index back to within one standard deviation, and 65 bps to bring it back to its historical average.
Another 9% drop?
The S&P 500 earnings yield is 6.17% based on 2022 earnings projections. A 30 bps increase would increase the yield to 6.47% and a 60 bps increase would increase the yield to 6.77%. Earnings yield is simply the reciprocal of the PE ratio. So the current PE ratio is 16.2 and would need to drop to 15.4 or 14.7 to bring the S&P 500 back to its historical average fair value.
With 2022 earnings projections currently tracking $224.73, the S&P 500 values range from 3,460 to 3,300. That equates to a further decline in the index of around 5% to 9%.
Interest rates and the dollar index are likely to tell us when this bear market will end. Because they are likely to give a much better signal than other indicators. If interest rates continue to rise, the S&P 500 needs to keep falling to match the pace of rising interest rates.
The 10-year minus the 2-year spread usually indicates when the Fed is about to start cutting rates. The point at which spreads start to rise tends to be the best metric for the end of a rate hike cycle and the start of a rate cut cycle.
2-year yields are starting to move back to 10-year yields as the market expects a Fed rate cut. On the contrary, the 10-2 year spread just hit a new low in September and shows little, if any, sign of a rise.
On the other hand, the best way to tell when the 10-2 year spread will start to rise is to look at the unemployment rate. Usually from 2010 to 2010 he shows spreads widening when unemployment starts to rise, suggesting a rate cut cycle is approaching.
In this case, Friday’s jobs report showed the unemployment rate fell to 3.5% from last month’s 3.7%, returning to its July low. This means the spread between 10-year and his 2-year Treasuries is far from bottoming out and the Fed is probably far from ending its rate hike cycle.
If the Federal Reserve isn’t nearing the end of its rate hike cycle, rates probably haven’t finished rising. So even if the stock market hits its short-term bottom at the end of October, the stock market bear market cycle could still continue.