The Real Problem for this Market
Stocks dropped last week thanks to disappointing economic data and not-as-good-as-expected guidance from AI-related tech firms and as a result the S&P 500 has backed away solidly from the July 16 highs. Additionally, the “mood” on Wall Street has turned a bit more somber as even the most buoyant economic optimists have to admit growth is clearly slowing. But while we have been in the “growth is slowing more than expected” camp for a while, it’s very important to maintain context as it happens and not get presumptively bearish.
Economic growth is undoubtedly and clearly losing momentum, but a soft landing remains more likely than a hard landing. Friday’s jobs report wasn’t good and the revisions were worse. But we’re still talking about 116k three-month average job adds. That’s not recessionary. Additionally, claims remain low (in any other era, 228k claims would be considered fantastic!). Finally, other growth metrics (ISM Services PMI, retail sales, durable goods) have plateaued but aren’t declining yet. Point being, if we’re looking at the data, this is what a soft landing looks like.
Now, could all this tumble into a hard landing? Of course! That’s the worry, but we must wait for actual evidence that’s happening and it’s not there, yet (and if it gets there, we are committed to tell you first). This matters because the problem with this market isn’t growth (it’s slowing but still pointing to a soft landing).The problem is valuations. At these levels the S&P 500 is trading at 20X next year’s earnings. That’s not a soft landing multiple (it’s more like 18-19 if we’re being generous). A 20X multiple is a “no landing” multiple and I get the impression investors are rooting for a soft landing, but their definition of a soft landing is basically stable growth. I’m afraid it doesn’t work that way.
This market remains susceptible to more disappointing economic or earnings news. And I think that means the S&P 500 could drop 200-400 points from here before it more accurately reflects the economic risks and prices in an actual soft landing (not a no landing that it’s calling a soft landing). If economic data stays about where it is now, the S&P 500 will be more appropriately priced and at that point, risks will skew to the upside.
For now, this market remains too optimistic for the growth reality, not because that reality is so bad, but instead because valuations are so stretched and as such, I continue to sit on 25% defensive value stocks until fundamentals improve. Until then, the election looms large. We will stay the course until the election and then make appropriate adjustments. I will be sending all of you a questionnaire that reflects what risk you want to take going forward along with a chart that demonstrates the expected volatility and average return for each risk. I will adjust portfolios to your new risk after the election.
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