Is the Market Fairly Valued?

12.20.2022 Market turbulence this year has shaken investor confidence, begging the question: Are we in a bubble that’s in the process of bursting? The key to the answer to this question is valuation. Market valuation, because it’s a function of earnings growth and interest rates, is mutable. This year is a prime example.  When we kicked off 2022, the S&P 500 was arguably fairly valued based on a 10-year note yielding 1.8 per cent and earnings growth expectations of 1.8 per cent. During the course of the year, earnings growth expectations increased but yields did too – by more than two percentage points.  Now, as we look out toward 2023, the equity market appears fairly valued through the lens of earnings and interest rates. The 10-year note yields 3.7 per cent and analysts are anticipating four per cent profit growth over the next four quarters. But what happens if the recession that economists and the bond market are forecasting for next year comes to pass?

S&P 500 Valuation Table as of December 31 2021
S&P 500 Trailing Earnings Growth History with Recessions

History has shown that 12-month earnings decline 10-20 per cent in recessions – a far cry from current expectations. All else being equal, a 15 per cent earnings decline would equate to a nearly 20 per cent pullback in equities from here. One offset, however, would be interest rates. We would expect that an economic pullback large enough to crater earnings would be likely coupled with a dramatic drop in interest rates. Our copper/gold model suggests the 10-year yield should be 1.3 percentage points lower than the current yield.

S&P 500 Valuation Table as of December 20 2022

Bottom Line: If we assume a less-severe-than-average recession next year – meaning an earnings contraction closer to 10 per cent – combined with a yield decline toward three per cent, then the market is fairly valued at current levels.

Cresset Favicon

About Cresset

Cresset is an independent, award-winning multi-family office and private investment firm with more than $45 billion in assets under management (as of 04/01/2024). Cresset serves the unique needs of entrepreneurs, CEO founders, wealth creators, executives, and partners, as well as high-net-worth and multi-generational families. Our goal is to deliver a new paradigm for wealth management, giving you time to pursue what matters to you most.

Receive Weekly Market Updates

From Chief Investment Officer, Jack Ablin.
We use cookies to improve your web experience, analyze site usage, and deliver personalized content to you. Some cookies are essential to site functionality, others are optional and help us see how the site is used or allow us to better service you.  By clicking “Accept” you are accepting all cookies. To better understand how cookies are used by us or to opt-out, visit Terms of Use.