Experts warn of another 25% downside

The shares have gained 12% since June 16. But according to Bill Smed, there are more downsides ahead of him. Smed compared the current sell-off to three previous bear markets with similar characteristics.

For Bill Smed, founder and CIO of Smed Capital Management, the current stock market selloff resembles some of the biggest bear markets of the past 60 years.

That’s bad news for investors, many of whom expect the stock to hit a permanent bottom after climbing 12% since mid-June.

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Smed, who started in 1980 at the now-bankrupt investment bank Drexel Burnham Lambert, said in a commentary Tuesday that he thinks the S&P 500 could “easily” fall another 15-25%, which would mean peak-to-peak Trough declines up to 36%, putting some well-known market drops selling in the company.

This is because there are three main properties present in the current environment that were trending in the 1968–1970 (–36%), 1973–1974 (–48.2%), and 2000–2003 (–40.1%) bear markets.

The first is the upbeat mood that gripped investors from March 2020 till 2021. In February 2021, he told Insider that the speculation through sectors such as crypto, meme stocks and FAANGs was “a silliness episode. The most mythical ever.”

Some investors are still clinging to their optimism, but that’s a mistake, Smed said.

“Should you buy stocks because they’ve fallen like the ones in 2000-2003? What makes a stock a value stock down 75% from the high? Will a seven-month bear market cure the associated sins? The frenzy of the last five years With? We don’t think so,” Smed wrote.

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This is because the stock valuation is very high. The price-to-earnings ratio of the S&P 500 was at 24 times earnings in January 2022. The historical average of the index is in the range of 14-17. Stocks were historically expensive in all three market sell-offs, which Smed also mentioned.

Then there’s a hawkish Federal Reserve presence. Inflation is at its highest level since 1981 (9.1%), and the Fed is aggressively tightening policy to cool it. That’s a bad sign for corporate earnings and economic growth, as the Fed expects consumer demand to ease. Experts at several Wall Street firms, such as Goldman Sachs and Morgan Stanley, are warning that earnings expectations for the rest of the year and next year still need to ease.

Finally, Smed pointed out that in the three prior selloffs mentioned, the bear market dragged on for at least a year and a half from its peak. The peak of the current decline was seven months ago, on January 3.

“It appears that history will tell us that this bear market has additional time to attract investors as most similar prior bears lasted a minimum of 18 months,” Smed said. “The S&P 500 index can easily take an additional 15-25% off current prices as the Fed tightens credit and P/E ratio compacts.”

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Smed’s views on where the market is headed next match those of some of Wall Street’s biggest strategists.

Morgan Stanley’s chief US equity strategist Mike Wilson said this week that stocks would fall another 20% if the US economy enters a recession. He said the gap between when the Fed stops hiking and when the economy enters recession is likely to narrow.

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“I think, eventually, it will be a trap,” Wilson said.

Savita Subramaniam, head of US equities and quantitative strategy at Bank of America, made a similar prediction in July, calling for a recession and a more than 20% decline.

Subramaniam said the bank’s derivatives team is of the view that equities are not discounting adequately if we are already in a recession.

Still, it’s a worst-case scenario for two strategists who are already in the most bearish state on Wall Street. Subramaniam’s target for the S&P 500 this year is 3,600 and Wilson’s is 3,900. Most strategists maintain targets above 4,000.

But again, the Fed has shown no signs that they will back down from their hawkish policy stance unless inflation eases in a significant way, with many calling for a fall in earnings projections. .

Some are demanding further lowering of valuations, despite the fact that so far all valuations have been sell-offs, not earnings.

Michael Leibovitz, a portfolio manager at RIA Advisors, told Insider earlier this month that higher inflation correlated with a continued decline in valuations.

He said the market’s cyclically adjusted price-to-earnings (CAPE) ratio currently sits at 28, well above the long-term average of 20. When inflation has previously been at 9%, the market’s CAPE ratio has typically been between 5 and 15.

RIA Consultant

Leibovitz said he wouldn’t rule out the S&P 500 falling to 2,600.

The direction of stocks going forward depends on the direction of inflation, how the Fed reacts, and how the economy reacts to both inflation and central bank policy.

The US economy posted negative GDP growth for the second straight quarter in a row, another sign that the economy is weakening amid tight competition from the Fed and crippling inflation. But many believe inflation peaked in July as commodity prices tumbled, and consumer spending remains positive year-over-year. The job market is also making impressive gains, and the unemployment rate is still at a historically low 3.6%.

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If inflation begins to fall massively, the Fed could show signs of a sluggish pivot in the second half of the year. If it doesn’t, the stock is likely to take a tough pull ahead as the Fed shows a higher resolve to crush rising prices.

“They’re going to keep monetary policy tight, even when inflation peaks,” Desmond Lachman, senior fellow at the American Enterprise Institute and former deputy director of the International Monetary Fund, said in an interview with Insider this week. “They are likely to keep the brakes on because they don’t want to screw up on inflation again.”

With that in mind, the stock could be headed where Smed thinks they’ll go — further down a bear market path.

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