Last Update: March 27, 2023

Jump to section: Valuation | Business Cycle Factor | Tactical Factor

Odds of a policy mistake are very high and the higher for longer message is still going to hurt the economy. Some catalysts are clear and there are likely additional unintended consequences of the rapid rate increases. While it appears now that we are much closer to the terminal rate, we do not see an easing until the market and Main Street feels more pain. Main street has felt no pain yet given the employment situation. We do not think the bottom is in until Main Street feels the recession. It does not have to be deep, but no cycle in history has ever bottomed at full employment.


Risk Level: 61%

Forward based EPS are still likely too high. So while valuations have moved back to more median levels, risk premiums are still elevated. At major cycle lows, valuations should be at a discount to fair value and longer-term averages. There is still more work to do ahead. Longer-term risk return is more balanced at current levels.

Enterprise Value to EBITDA

A reading about 50% historically means the average returns over the coming years will likely be about average. Valuation metrics are not great timing indicators, but looks to frame longer-term expectations and magnitude of a correction when a catalyst develops. Enterprise value (EV) is the amount of debt plus equity capital a company uses less cash like holdings to generate free cash flow. EBITDA and EPS expectations are likely far too high given the tighter financial conditions that are likely to continue for a while longer. The challenge with valuation ratios is that the divisor is a forecast and will change over time.


A reading near 60% historically means the average returns over the coming years will likely be slightly below average. While the market is only modestly expensive historically, this metric suggests longer-term returns will be somewhat less than average and should not be specifically used as a timing indicator, but adds to the cautionary environment. The revenue a company generates is less subject to manipulation (financialization) like earnings per share can be and can be a better valuation metric than comparisons to earnings. Many industries have higher margins, so price-to-sales is not a perfect guide. With several recessionary indicators now fully flashing high risk, decay in the employment picture would cement an earnings recession. With nominal growth still strong, revenue growth is still likely, but margin pressures are building and volumes are already in decline. This should negatively impact EPS going forward.

Forward P/E

A reading near 40% historically means we should expect slightly above average return over the coming years. Forward P/Es should not be used as a timing indicator, but rather a guide to current longer term expectations. Earnings expectations are a key factor for longer-term market growth. Forward P/Es historically are 2 multiple points below trailing average. The historic average P/E for US large caps is about 16.5x earnings versus the current forward P/E of 18.08. Over the past 3-months forward EPS estimates have decreased by -0.61%. Over the past month, forward EPS estimates have decreased by -0.32%. The rate of EPS change is declining at a slower place.

Equity Risk Premium

A reading near 90% historically means the average returns over the coming years will likely be well below average. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary environment. The equity risk premium is the discount factor investors are paying for stocks above the risk free rate. The inverse of the P/E called the earnings yield plus the long-term government yield is a reasonable estimate. Overall, the ERP declined 10.2bps last week. The yield of the 30-year bond increased 2.4bps. The earnings yield of the S&P 500 declined 7.8bps. The tightening of financial conditions is likely to continue in the short run. But we are very close to fully pricing in the terminal rate of Fed funds and weakening of the economy and earnings should start to balance out. Markets remain on the expensive side, but it’s mostly because of higher rates.


Risk Level: 85%

The cost of money and credit is no longer stimulative and risk factors are very high. The yield curve is certain a recession is likely and credit is not appropriately priced, though absolute yields are much higher. Overall business cycle risk is still very cautionary.

Slope of Yield Curve

A reading near 100% suggests the yield curve (3-months vs. 10-years) is forecasting recession within the next 12 months. An inverted yield curve leads to credit contraction as lending profitability is curtailed. A curve this flat suggests financial conditions are extremely tight. The recent trend has been flatter. Last week, the 3M-10Y curve was 28.5bps flatter. The forward curve is pricing in only modest rate cuts by mid 2023. Powell launched the higher for longer narrative and we expect the curve to remain in recession mode until inflation clearly breaks. This restrictive curve could last into 2024, though the recent banking insolvencies can complicate the FOMCs job fighting inflation.

High Yield vs. Investment Grade Credit Spreads

At a reading near 80%, credit spreads are at very wide levels and suggest tight financial conditions and some economic risks ahead. At some point, the worst case is priced in, but this is never a moment in time, but a process over weeks or months. Wide credit spreads correlate with high business cycle risk. If we start to see equities perform better with more bad news, it’s a sign that the worst may be behind us. The yield-to-worst (maturity) for junk bonds is 8.98%, which is -2.1 standard deviations below average. The FOMC and other central banks are reducing liquidity, but big picture it is still ample. Looking out, we should expect tighter financial conditions and wider credit spreads. Over the past month, HY-IG spreads are 65bps wider. Over the past 3 months, HY-IG spreads are 45bps wider. Momentum is increasing.

NY Fed Weekly Leading Indicators

Over the past week, the NY Fed weekly leading economic index increased. The trend over the past month is rising at a slower pace. The recent trend suggests evidence of modest contraction. Growth challenges are significant without deficit driven stimulus. For more details see:
We are now past the stimulative phase of the cycle and looking ahead, quantitative tightening (QT) will likely provide a major hedwind for risk premiums. The labour market remains the stickiest part of the core inflation push with real assets showing signs of deflation.

Real Yields & Inflation Expectations

Over the past week, real 10-Year Treasury yields declined -11.3bps. Nominal yields decreased -5.2bps, while long-term inflation expectations rose 6.1bps to 2.55%. Real monetary policy is tight relative to long-term expectations. Short-term inflation numbers remain extremely elevated, while longer-term market based inflation expectations are elevated relative to the range of the past decade. Based on recent curve moves, the market has likely priced in more tightening than the FOMC actually will need to do given increasing odds of a recession.


Risk Level: 20%

Last week markets moved off the extreme oversold conditions and still support a buy dips trading bias. We can see that the performance of the equal weight S&P 500 continues to underperformed the tech heavy market cap weighted index. Small caps also performed very poorly. Financial conditions tightened, but the large cap averages masked this behaviour. The tactical aspect of the market points to an oversold condition, but the bigger picture is not set up for a sustainable rally. While this type of set-up can lead to strong rallies, we do not look to play them at the moment. The risk/return is more compelling closer to the Sep/Oct lows. We think there is a high probability those levels get tested.

5-Day Put/Call Ratio
Risk Level: 4%
The Put/Call ratio measures a degree of speculation and hedging in the options markets. A reading near 0% suggests an extreme fear is being priced in to markets. Last week, the average put volume increased 4,710 contracts per day while the average call volume increased 1,397 contracts per day.
Speculative Position S&P 500 Futures
Risk Level: 4%
Positions of speculators in the S&P 500 futures contracts offers a potential future source of supply or demand. Current readings are very bullish and extreme enough that it is a contrary indication. As of March 21, S&P 500 E-mini speculators increased their net short position last week by 4,133.1 million dollars. The overall short position suggests a high degree of short squeeze potential and is a bullish factor.
Percentage Deviation from 200-Day Moving Average
Risk Level: 30%
When the market is close to the 200-day average, it could go either way. If recently trends are bearish it can act as resistance. If recent trends are bullish, it can act as support. In volatile markets, it has somewhat less meaning. Timing can be difficult and we need other confirming indicators to identify the opportunity. The 50-day average is now above the 200-day average (Golden Cross), but the trend over the past month is weaker. The 200-day average held a key test last week. It must continue to hold or the bull-trend signal will turn bearish again.
AAII Bull vs. Bear Sentiment Spread
Risk Level: 4%
When the percentage of Bulls exceeds the percentage of Bears by a significant amount, we are likely much closer to a mark bottom than a top. Last week the percentage of bulls increased 1.7% while the percentage of bears increased 0.5%. Over the past month we have seen extremely bearish sentiment, which happens frequently in bear markets, but also sets up a high probability of a counter trend rally.
Seasonal Pattern (All Years) Since 1928
Risk Level: 58%
The 1-Month forward based return is slightly below average based on the 4-year presidential cycle model. The second year of the presidential cycle offers the most volatility and lowest returns on average of all years combined. With both a fiscal and monetary reversal in play, there is a strong catalyst for poor returns this year. We are over weighting seasonal factors this year.
Presidential Cycle (Current Year) Since 1928
Risk Level: 17%
The 1-Month forward based return is well above average and provides a good tailwind based on the current year of the presidential cycle model. The second year of the presidential cycle typically is the worst of all. That tilts the bias a bit in favour of being more cautious when seasonal factors are weakest. That expectation is historically seen between March and September.
Current vs. Average Volatility (VIX)
Risk Level: 45%
Last week, volatility was -14.8% below the previous week. It was +3.8% compared to it’s 50-day average. The 50-day average is 6.0% above it’s long term trend. We expect volatility overall to remain elevated as we mov through the recession in 2023. A cooling of inflation pressure should be welcome and help to reduce uncertainty, but higher for longer means more pain coming.
Current vs. Future Volatility (VIX)
Risk Level: 33%
Last week, current volatility was -9.4% below the previous week. Future volatility was -4.0% below the previous week. The ratio of current volatility to future volatility is now close to inverted. Volatility levels remain elevated. We expect this to continue as investors debate central banks taking the punchbowl away while waying the risks of WWIII.
Percentage of S&P 500 Holdings Above 50-Day Average
Risk Level: 4%
The percentage of stocks in the S&P 500 above their own 50-Day averages is 23.3%, which is 2.6% above the previous week. It is 8.4% below the average of the past month. Tactically, extremely close to a strong oversold buy signal. It’s now been a few months since the market made its all-time high and so the opportunity for more stocks to break trend has developed. The 50-day average will cross below the 200-day average this week. Look for an oversold rally soon, but a move to new highs is unlikely until the reasons for the market corrections have been fully priced in. That could take a while given the rate hike cycle just started.
Percentage of S&P 500 Holdings Above 200-Day Average
Risk Level: 12%
The percentage of stocks in the S&P 500 above their own 200-Day averages is 43.1%, which is 4.0% above the previous week. It is 7.2% below the average of the past month. Statistically, breadth readings are extremely oversold and odds of a rally are high once a catalyst develops. At this point we need a friendly FOMC and a ceasefire in the Russia-Ukraine war.
Breadth-McClellan Summation Index
Risk Level: 7%
The breadth of the market is extreme near record lows. Few stocks are participating in the advance. Overhead divergences suggests that a rally to new highs is unlikely. But there should be enough support buying dips as long as earnings fundamentals hold up.
Overbought-Oversold 13-Week Relative Strength Index
Risk Level: 22%
The 13-week RSI is a neutral 50. Overall, RSI has much higher signal efficacy at extremes and better at bottoms than tops. The extreme seen last week coupled with the bullish weekly chart pattern suggest decent bounce potential. This is likely “a” bottom, but probably not the bottom.