11 Stock Market Charts That Offer Much Needed Context

Stocks fell last week, with the S&P 500 shedding 2.4% to close at 4,224.16, the lowest level since June 1. The index is now up 10% year to date, up 18.1% from its October 12, 2022 closing low of 3,577.03, and down 11.9% from its January 3, 2022 record closing high of 4,796.56.

There seems to be a lot on investors’ minds lately. Fortunately, there are also lots of really smart people sharing charts that help contextualize all these issues. Below are a few that were circulating over the past week.

Year 2 Is Usually Good

October 12 was the anniversary of the bear market low, marking the beginning of the second year of the current bull market. Here’s Oppenheimer’s Ari Wald on the historical comparisons: “…we define a cycle low as an 18-month low. … Our analysis indicates year 2 following a major low has been positive in 19 out of 22 cycles (86% of the time; the misses occurred in 1932, 1947, and 1960), and we’ve found little relationship between year 1’s magnitude and year 2’s return.“

(Source: Oppenheimer)

Quick take: The stock market usually goes up, and this is more evidence of that. Since 1950, the stock market has been in a bull market 83% of the time.

Don’t Expect Smooth Sailing

BMO’s Brian Belski also observed that bull markets usually extend through year two, but he cautioned that a correction would be normal. From his research note Wednesday: “…despite history pointing to lower volatility in the months ahead, we still believe there will likely be some choppiness along the way as the believability of the bull market continues to get questioned. As Exhibit 6 shows, the S&P 500 has still averaged a roughly 10% max drawdown in the second year of bull markets.”

BMO

Quick take: There’s a reason why TKer Stock Market Truth No. 2 is: “You can get smoked in the short term.“

It’s The Good Part Of The Presidential Cycle

Stocks have been following a familiar pattern this year. Here’s Carson Group’s Ryan Detrick: “The third year of a new President tends to see strength the first half of the year (check), then chop into Thanksgiving (so far a check) and then a strong rally into the election year.“

(Source: Carson Group)

Quick take: I wouldn’t go all-in on the idea that stocks will move higher from now into year-end. The stock market is just too unpredictable during these extremely short-term periods.

Bonds Are Becoming More Attractive Relative To Stocks

All eyes have been on rising interest rates. Rising interest rates have made asset classes like cash and bonds appear increasingly attractive relative to stocks, and stock dividend yields aren’t much higher and valuation ratios aren’t particularly compelling. X user Quantian1 observed that the yield on the 30-year Treasury bond is now higher than the S&P 500’s earnings yield (that is, earnings / price).

(Source: @quantian1)

Quick take: The risk profiles and return opportunities for these various asset classes are very different. For example, companies can grow the earnings that go into those earnings yield calculations, and earnings are the most important long-term driver of stock prices.

CNBC’s Michael Santoli shared a chart of a calculation of the equity risk premium (that is, the difference between the earnings yield and the Treasury yield). Similar to the chart above, it shows that stocks haven’t been this unattractive to bonds in two decades. But Santoli had some good perspective critiquing the metric when he was on Morningstar’s The Long View podcast:

“So, when we go back to that spread between the earnings yield of the S&P 500 and let’s say, the 10-year Treasury, right now, that seems like there’s just no valuation cushion at all for stocks. We’re as low as we’ve been in 20 years-ish. But if you go back to the ‘80s and ‘90s, this level was absolutely routine and unremarkable, and the market went up most of that time… I guess, my big point is, I just don’t have a lot of faith in the precision of those relationships. The biggest equity bubble in history happened when yields were at 5% and 6% and 7%… I don’t have a ton of confidence in the precision of those relationships because it’s very regime-specific.“

(Source: Michael Santoli)

Lots more to say on this, but that’s all for now.

The End Of Fed Rate Hikes Usually Isn’t Bad

With inflation rates cooling towards the Federal Reserve’s target levels, Fed Chair Jerome Powell and his central bank colleagues have increasingly signaled the last interest rate hike is near or has already happened. History says that usually isn’t a bad sign for stocks. From Bloomberg’s Gina Martin Adams: “No such thing as a bad Fed pause, as far as stocks are concerned. There have been six instances since 1970 in which the Fed raised rates by over 100 bps for a period of a year or more, then paused for at least 3 mos. The S&P 500 was up all 6 times during the 3 mos, an avg 8.2%.“

(Source: Gina Martin Adams)

Quick take: I think I’d be more concerned if the end of rate hikes this cycle were happening amid a high likelihood of a recession. But recession odds have been falling.

Higher Rates Aren’t Yet Crushing Profits

Despite three years of rising interest rates, interest expenses haven’t really budged for S&P 500 companies. From BofA: “The effective interest rate is on the rise, but only back to pre-COVID levels.“

(Source: BofA)

Quick take: The big S&P 500 companies continue to benefit from the fact they refinanced much of their debt in recent years, locking in historically low rates. This has bought them time to make adjustments to their operating and capital structures should they need to refinance again at much higher rates.

It’s worth noting the urgency is a bit higher for small cap companies as they have much more debt maturing in the coming years.

(Source: BofA)

Cash Levels Are Coming Down From Elevated Levels

From Goldman Sachs: “S&P 500 cash balances fell by 4% during the past 12 months. Cash to assets for the aggregate index now ranks in the 13th percentile since 2010 and in the 9th percentile for the typical stock. The challenge of weaker cash balances will be compounded by the more restrictive financing environment. … Higher rates will reduce the appeal of using debt to fund large cash spending plans, given the potential for higher borrowing costs.”

(Source: Goldman Sachs)

Quick take: Falling cash levels would be worse if it weren’t occurring from historically high levels. That said, this bears watching, especially should high interest rates persist.

Companies Are Getting More Out Of Their Workers

The revenue per worker that S&P 500 companies are getting is historically high. From BofA’s Savita Subramanian: “Labor efficiency has been inching toward the record high from 2008.“

(Source: BofA)

Quick take: On one hand, this has been bullish for corporate profit margins. On the other hand, it’s no wonder so many workers are demanding higher wages and going on strike.

The Earnings Outlook Remains Favorable

Despite all the headwinds we’ve read and heard about, analysts expect next-12 month earnings to hit record highs.

(Source: Morgan Stanley)

Quick take: As I’ve argued in TKer Stock Market Truth No. 5: “Any long term move in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.“

Despite all of the concerns out there, we continue to get data confirming that job creation remains robust, personal consumption continues to grow, and capex orders continue to point to more business expansion. All of this points to more economic growth, economic growth helps drive earnings growth, and earnings are the most important long-term driver of stock prices.

A version of this post was originally publishedo on Tker.co.