Equity Selloff: What Inning Is It?
Vice-President, Chief Economist and Strategist
This is probably one of the most chaotic economic and financial environments we’ve ever seen. But high volatility can make for attractive market opportunities—if you can stomach the swings. Some investors have begun asking whether it’s time to pivot to stocks. Right now, the forward price-to-earnings ratio is at about 18, which is still above its 40‑year average of 15.5. Since hitting an all-time high in September 2020, however, the S&P 500’s forward price-to-earnings ratio is two-thirds of the way back to its long-term average. If the recent selloff continues, equities could soon look pretty cheap.
But timing the market is a gamble, even in normal circumstances. And it’s even worse these days when everyone is talking about stagflation.
Our outlook for the rest of the year calls for slowing but positive growth and uncomfortably high inflation. When inflation is largely the result of strong demand, corporate sales and earnings are usually also strong. Markets in turn get bullish on prospects and equities thrive. But if inflation is due to surging prices for energy, labour and other inputs, earnings get squeezed unless firms can boost productivity or pass on higher costs to consumers. However, they can only sustainably pass on costs if disposable income keeps up with inflation. And right now it isn’t, as we discussed in a recent Economic Viewpoint.
Meanwhile the Fed needs to keep tightening. Its policy is still too accommodative and its credibility is on the line.
All in all, it appears we may be on the road to stagflation, which is one of the worst scenarios for equities.
What could stop the market madness? Reassuring inflation signals. This week’s US CPI report confirmed that inflation peaked in March, but it also showed core inflation picking up more than expected in April. So long as the disinflation outlook remains blurry, it will be difficult to make a solid case that investors should overweight equities.
“Don’t fight the Fed” used to mean that trying to short bonds was futile. Now it means being long on risk assets is foolhardy. Chair Powell kept the door shut to a 75‑basis-point hike this week. In our view, it’s too soon to provide dovish forward guidance. Even former New York Fed President Bill Dudley suggested his former colleagues lift rates to at least the 4% to 5% range and stop sugarcoating their messaging. Our baseline assumption remains that the Fed will move by 50 basis points at its June 15 meeting. However, the May inflation report will be released less than a week before. If inflation comes in stickier than expected, all bets are off.
So where does that leave investors looking to time the bottom of the market and hit it out of the park? Let’s just say it’s too early in the game.
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