“Some discomfort is normal but call me if the pain gets worse,” the doctor will say, and let the patient draw the line between tolerable and worrisome. Investors in the five months since stocks peaked have mostly felt a typical degree of discomfort with the process the economy and markets are going through: Valuing in a tight inflationary state, began a cycle of fiscal tightening, growth decelerating and, as a result, revaluation. It remains unclear whether all of this will overcome the severe distress and longer-term decline in asset values, given several key macroeconomic factors – nominal bond yields and in fact, the fall in earnings and oil prices – remains well below Wall Street’s obvious pain threshold. Last week’s market action – S&P 500 index slips 1.2% in indecisive, indecisive trade, holds back most of 9% gain from May 20 low while falling heavily The right reason for an extra break – fits well with this kind of everyday discomfort. It is fair to observe that skepticism prevails as to whether a two-week low, just above 3800, is a reliable bottom, and with good reason: Previous rallies in this year just stops at lows before there are more new lows. Long-term downtrend is still maintained. And it’s hard to see anything like an “all clear” signal to early risk taking given the Federal Reserve’s sole focus on raising interest rates higher to counter an inflationary trend. development, even if it has reached its peak, cannot prove that point to some other month. However, last week’s market slide has little to do with the case that the recent rally is fairly well supported and could continue higher to test the nerves of the confident asserting that all rallies should be sold. Bottom or price bounce? Positive market breadth statistics skewed from the first three days of bounce off the lows have triggered some trending signals with pretty good long term implications for returns months to months to a year (with some major exceptions being the multi-year bear market recession that began in 2000 and 2007). Stocks are also compatible with other asset classes. The S&P 500 index is within half a percent of where it was four weeks ago, and the two- and 10-year Treasury yields, junk bond spreads, and S’s full-year 2022 earnings forecast The &P 500 is similar. same place now as they were there. A model used by Fidelity macro strategist Jurrien Timmer to estimate the fair value of stocks based on yields on 2-year Treasuries (as a proxy for the Fed’s policy line). enjoy most of the compression in stock valuations this year. The slope tracks well, although the stock is still slightly above the appropriate value implied. Timmer believes that because the decline in P/E for the year merely brings it to the fair rather than cheap range, upside could be limited even if fundamentals should support the level well. recent low. A market that is experiencing uncertainty and weathering known headwinds but is yet to be forced into pricing in truly painful potential outcomes – this is the theme of the moment. Deutsche Bank strategists, who monitor investment stances of all types of investors on Friday, reported that “while slowing growth appears to be broadly priced in, very little [positioning indicators] is falling into recession. “This makes perfect sense, given that last week’s jobs report and ISM manufacturing survey showed nothing approaching recessionary conditions. much of it has fallen, however short-term interest rates are low and households are looking for a way out. The family continues to perform historically high stock allocation earnings forecasts Henry McVey, chief investment officer of KKR & Co., said he believes the market is currently transitioning from a mode where inflation is The main concern shifts to expectations of a significant cut in earnings in the second half of the year and into 2024. Morgan Stanley notes that the revised earnings breadth – the real percentage increase over the cut – has Looks like it’s about to turn negative Not great, but the S&P 500 Annual Profit Path shows this is not exactly news for the market and at one point the metric cracked below zero in a mid-cycle recession rather than a recession, with Fed officials last week repeatedly beckoning investors to give up hope that they will look for an opportunity to pause the war With interest rate hikes looming in the coming months, yields appear to be one of the more obvious things that could test equities. Tracking rates, oil 10-year yields have rebounded to the 3% threshold, not far from the 3.1% above peak it briefly hit in early May, itself just below 3.25% was achieved at the end of 2018, which helped trigger a rapid stock market decline in late December of that year. A break above this zone also represents a breach of the multi-decade downtrend in yields, so such a move would go unnoticed. Real rates – yields adjusted to the market’s implied inflation expectations – are another thing to watch for in the hunt for potentially painful sources. Real productivity has recently turned positive again. When it rose to 1% in 2013, it coincided with an attention-grabbing but ultimately benign “rage.” Similar levels at the end of 2018, later in the cycle and with more expensive stocks, demonstrate tougher digesting of stocks, whose near 20% drop ended when the Fed signaled a pause in efforts. his tightening. To be sure, a spike in oil prices above the war panic-inducing peak in March of $130/bbl for WTI crude (from $120 today) would also be an obvious additional challenge, although it is still a lighter burden now than 2011-2014 adjusted for the larger size and lower energy intensity of today’s economy. It’s fair to say that there’s no shortage of potential sources of pain. However, the market has absorbed a lot of discomfort and hasn’t broken out definitively, in large part because investors in general have been scared and faltering for months now, anticipating more pain. is the pursuit of pleasure.