Regular readers know I’ve spent decades using data to track Wall Street. But sometimes, Wall Street just comes right out and tells you exactly what it’s thinking…
JPMorgan Chase CEO Jamie Dimon is Wall Street’s ultimate insider.
Earlier this month, he warned folks to get ready for a financial “hurricane.” And he followed it up by saying that he “just wouldn’t bet” on the hoped-for “soft landing.”
Now, the phrase “soft landing” is important. Dimon is alluding to the Federal Reserve…
The Fed hoped to cool inflation without leading to a major recession. But folks, that looks less likely by the day. And now, Wall Street’s ultimate insider is echoing that sentiment.
It’s not surprising. Inflation is rampant. And the Fed’s plan to tame the beast involves a series of large interest-rate hikes and a rapid unwinding of its balance sheet.
During 15 years of monetary and fiscal stimulus, price inflation didn’t occur – but asset inflation did. By that, I mean growth stocks, cryptocurrencies, special purpose acquisition companies, leveraged buyouts, and more all benefited from the Fed’s “easy money.”
Mega-growth stocks, story stocks, and bitcoin alike defied gravity and soared to excessive heights during the golden era of quantitative easing and fiscal stimulus.
But that has all changed now.
The Fed’s unwinding of these excesses isn’t over. And the day of reckoning is getting closer.
In short, a three-fold dynamic is driving stock prices lower…
- Rampant inflation higher than 8%, year over year
- Impending interest-rate hikes and deleveraging of the Fed’s balance sheet
- A collapse in price-to-earnings (P/E) ratios – particularly for the megacap and speculative growth stocks that led the bull market to all-time highs
The P/E ratio for the S&P 500 Index has already fallen a lot from its peak. But the thing is… it can drop even further if growth hits a wall.
In past Fed rate-hike cycles that were fast like this one, P/E ratios didn’t bottom out until well into a bear market. That’s when analysts started cutting their earnings estimates.
That brings us to the biggest unknown – and the biggest risk – for the stock market…
I’m talking about corporate profits in the second half of 2022.
Wall Street analysts are still looking for a robust rebound in corporate profits. But that seems very optimistic…
Remember, inflation is rising sharply. As a result, input prices and wages are also rising.
With that in mind, company guidance alongside second-quarter earnings reports could be weak. And that could lead Wall Street analysts to lower their full-year 2022 estimates.
That would cause a further contraction of P/E ratios. And in turn, that could generate a broad liquidation of stocks.
That’s how market bottoms form.
Be prepared for a washout buying opportunity to happen later in 2022. It could happen in September or October. By then, the S&P 500 will likely be between 3,400 and 3,600.
For now, the market is telling us to keep looking into the hottest industries. Focus on energy, metals and mining, chemicals, food, aerospace, defense, and health care.
And on the flip side, we want to avoid struggling sectors. Today, those sectors include technology, consumer discretionary, and telecommunications.
Until a bottom has formed, we need to stay patient and focused. It’s always tough to stick to our game plan. Fortunately, our best opportunity could come sooner than you realize.
Good investing,
Marc Chaikin
