Last Update: November 28, 2022

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

If a cyclical bear market is beginning given the difficult job that central banks have for the next few years, the longer-term bias has to be towards selling rallies and positioning portfolios as boring as they can be. Lower P/E stocks, more value and earnings quality makes sense for the next few years. We see sticky inflation building, which should be tough for most asset markets. It will be easy for the Fed to get inflation from 9% to 5%, but from 5% back to 2% will be WAY WAY WAY more difficult without breaking something. And Break it they will!


Risk Level: 68%

Valuations overall are a little above average if one believes that forward based EPS are reasonable. If we are heading for recessions as our business cycle indicators are suggesting, then we will likely see the earnings side of the outlook decay. This suggests rallies are to be rented for now and lower lows are likely with earnings decay as the next phase. We are seeing forward based guidance fall, but do not see yet near a recession being priced in. Typically markets do not bottom until forward expectations turn negative in a recession. There are all sorts of benchmarks to consider when trying to predict a bottom. Earnings expectations are a big one.

Enterprise Value to EBITDA

A reading about 60% historically means the average returns over the coming years will likely be modestly below 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. Earning before interest taxes depreciation and amortization (EBITDA) has improved significantly over the past year while recent weakness in stocks and bonds has lowered EV. While not compelling given the recession risks still to play out, these are the best valuations since the COVID lows.


A reading near 70% historically means the average returns over the coming years will likely be below average. While the market is modestly expensive historically, this metric suggests longer-term returns will be below average and should not be 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 50% historically means we should expect about an 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 18.26. Over the past 3-months forward EPS estimates have decreased by -2.58%. Over the past month, forward EPS estimates have decreased by -0.59%. The rate of EPS change is declining at a slower place.

Equity Risk Premium

A reading of 100% 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 increased 10.6bps last week. The yield of the 30-year bond declined 19.3bps. The earnings yield of the S&P 500 declined 8.8bps. 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: 84%

The cost of money and credit is no longer stimulative and risk factors are very high. All factors are now cautionary, while credit spreads are wide and may already be pricing in economic decay, the real economy has not seen the pain yet. Parts of the economy are in contraction, but labour demand remains relatively strong through October. Some are arguing there is decay in the labour outlook below the surface. Basically, the only part of the economy not in contraction is the consumer. Consumption still remains “nominally” positive, though credit balances are rising and volumes have been in decline for several months in the retail sales and industrial output reports.

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 21.7bps 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.

High Yield vs. Investment Grade Credit Spreads

At a reading near 60%, credit spreads are slightly wider than long-term average levels and suggest modestly tighter financial conditions. Widening 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 9.19%, which is -2.5 standard deviations below average. Credit spreads are finally reacting to tighter financial conditions. The problem with the market is not credit related, as liquidity remains ample, but is being withdrawn at the fastest pace in decades. Credit widening portends economic weakness, which we are closely monitoring. The hot inflation pressure is not as much a business cycle effect as it is a supply side issue. If credit spreads start to lead wider, we have bigger trouble. They should stabilize for now and are attractive in the IG space. Over the past month, HY-IG spreads are 11bps wider. Over the past 3 months, HY-IG spreads are -10bps narrower. Momentum is increasing.

NY Fed Weekly Leading Indicators

Over the past week, the NY Fed weekly leading economic index slowed. The trend over the past month is slowing at a slower pace. The recent trend suggests evidence of modest contraction. Growth challenges are significant without deficit driven stimulus. For more details see:
There are severe distortions in leading indicators due largely to the start stop nature of the COVID influence and massive start top stimulus. However, the combination of tighter fiscal and monetary policy is being reflected in the broader economy.

Real Yields & Inflation Expectations

Over the past week, real 10-Year Treasury yields declined -23.2bps. Nominal yields decreased -15.1bps, while long-term inflation expectations rose 8.1bps to 2.58%. 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: 41%

A few short-term indicators are modestly overbought, but nothing extreme at all. Positive seasonals still leave the market open to upside surprises. That said, how much is the market front running a FOMC pause? This week Powell likely confirms the slower pace, but doubles down on the higher for longer narrative. We’ll see if that spooks the more speculative nature of the rally.

5-Day Put/Call Ratio
Risk Level: 47%
The Put/Call ratio measures a degree of speculation and hedging in the options markets. A reading around 50% suggests balance between bullish speculation and bearish protection. Last week, the average put volume declined 4,735 contracts per day while the average call volume declined 5,350 contracts per day. The data is stale here as it was prior to the CPI report.
Speculative Position S&P 500 Futures
Risk Level: 3%
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 November 15, S&P 500 E-mini speculators increased their net short position last week by 1,279.3 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: 23%
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 recently crossed below the 200-day average and marked the recent low perfectly. It suggests rallies should be sold until the current anxiety has passed. The bias has shifted far more towards selling rallies for now despite the market behaviour as the trend lines crossed. The failure to hold above the 200-day on the recent rally is a significant negative signal. Rallies can happen, but likely fail to make higher highs.
AAII Bull vs. Bear Sentiment Spread
Risk Level: 19%
When the percentage of Bulls is well below the percentage of Bears, there is plenty of pent up demand and cash to buy. Last week the percentage of bulls decreased -4.6% while the percentage of bears increased 0.0%. 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: 9%
The 1-Month forward based return is significantly above average 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: 40%
The 1-Month forward based return is slightly below average 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: 88%
Last week, volatility was -11.3% below the previous week. It was -24.4% compared to it’s 50-day average. The 50-day average is 37.6% 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: 65%
Last week, current volatility was -8.3% below the previous week. Future volatility was -4.0% below the previous week. The ratio of current volatility to future volatility is normal. 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: 93%
The percentage of stocks in the S&P 500 above their own 50-Day averages is 90.3%, which is 7.2% above the previous week. It is 14.6% above the average of the past month. Current levels are showing very strong trends. 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: 44%
The percentage of stocks in the S&P 500 above their own 200-Day averages is 63.2%, which is 7.2% above the previous week. It is 13.0% above 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: 36%
The breadth of the market is somewhat weak. Fewer 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: 29%
The 13-week RSI is a neutral 53. 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.