Welcome to RBC’s Markets in Motion podcast, recorded December 20th, 2023. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
Today in the podcast, our last of 2023, two big things you need to know:
- First, with just a few trading days left to go in 2023, the S&P 500 is close to a level that our valuation model has been suggesting is a reasonable one.
- Second, while we remain constructive on the year ahead, several charts that we track regularly are starting to suggest that the rally in the S&P 500 is due for a pause.
If you’d like to hear more, here’s another five minutes.
Now, let’s jump into the details.
Takeaway #1: The S&P 500 Seems Poised To End The Year At A Level Our Valuation Model Suggests Is Reasonable
- Though we were more constructive than many of our peers on 2023, we weren’t nearly constructive enough. We started the year with a year-end S&P 500 target of 4,100, which we raised to 4,250 in May.
- In hindsight there was one model that we should have paid more attention to. That was our valuation model, which was consistently the most constructive tool in our toolkit all year. That model uses the relationship between trailing average P/E’s and inflation, GDP, and interest rates dating back to the 1960’s to project where the trailing P/E of the S&P 500 should be at year-end based on consensus macro forecasts.
- This model has recently been suggesting that the S&P 500 could end the year at a 21.1x P/E or a year-end price of close to 4,700 when used in tandem with our $223 full-year 2023 S&P 500 EPS forecast.
- Back in August, before YE 2023 10 year-Treasury yield forecasts had finished moving up, the model was pointing to a YE 2023 P/E of 21.8x or close to 4,800 on price.
- What this model is telling us about 2024 has been a big topic of conversation in our recent investor meetings. Currently, it’s calling for a trailing P/E at YE 2024 of 23x, or around 5,300 when used in tandem with our 2024 EPS forecast of $232.
- Even if 2024 gets off to a rough start, which is normal in a Presidential election year, we think 2024 will end up being another positive one for the US equity market.
Takeaway #2: Risks of a Short-Term Pause in the S&P 500’s Rally Have Grown
- While we remain constructive on the US equity market in the year ahead, another topic that’s been coming up in our recent investor meetings has been whether the rally in the S&P 500 is due for a pause.
- We think the risks of a pullback have risen for a number of reasons. These include:
- Net bulls in the AAII survey are tracking at 25.7% on the four-week average, more than one standard deviation above it’s long-term average.
- When this indicator is between one and two standard deviations above it’s long-term average, the S&P 500 tends to be up 6.5% over the next 12 months…
- but is flat over the next 3 months.
- This echoes what we are seeing the weekly CFTC data on asset manager positioning in S&P 500 futures, which is close to recent peaks.
- Nasdaq futures positioning is also stalling after breaking out to new post 2015 highs.
- US valuations are back to peak relative to Europe, at a time when many non-US based investors are expressing concern about the 2024 Presidential election in the US. We worry the uncertainty around this event could encourage profit taking in US stocks in early 2024.
- Inflows to US equity funds may also be starting to stall….
- at a time when flows to equity funds focused on several major non-US geographies are starting to improve.
- Leadership rotation, specifically outflows from Growth funds, are part of what’s driving the weakness, reminding us that the when Growth lags Value, US equities tend to underperform non-US equities.
- Finally, in three of the past four years, and six of the past ten, the S&P 500 has been down in January. Seasonal trends have mostly been working in recent months as well.
That’s all for now. To all of our regular podcast listeners, we are so grateful that you are keeping us in your queue. We look forward to continuing the conversation about the equity markets in the new year, and wish you all a very happy, holiday season.