Stock-market rally looks ‘unsustainable’ as S&P 500 enters ‘new, lower valuation regime,’ warns Citi

This 12 months’s stock-market rally has pushed the S&P 500 index to valuation ranges that make it troublesome for the index to climb a lot greater primarily based on the present macroeconomic atmosphere, in response to Citigroup Inc. 

The S&P 500’s trailing price-to-earnings ratio is again to 18.2x, “dangerously close to the upper end of our fair value range,” Citi analysts stated in a analysis report dated Jan 13. “We are comfortable with a 3700-4000 S&P 500 trading range call for now.”

U.S. shares have rallied to this point this month, with S&P 500 up 4.2% by means of Friday, as buyers headed right into a three-day weekend honoring Martin Luther King Jr.  On Tuesday afternoon, the index
was buying and selling down 0.1% at round 3,994, in response to FactSet knowledge, ultimately verify. 

“For now, we suspect valuation could put a near-term cap on upside momentum,” the Citi analysts stated.  “Based on our fair value framework, valuations much above current levels are unsustainable unless there is a significant change in the macro backdrop.”

In Citi’s view, the S&P 500 is coming into “a new, lower valuation regime” in contrast with the interval seen because the world monetary disaster of 2008. 

“This implies index gains in this new environment will need to be ‘earned’ vis-à-vis near- and medium-term fundamental improvement, less so from macro tailwinds behind multiple re-rating triggered by lower interest rates,” the analysts wrote. 

Citi’s honest worth framework implies an S&P 500 price-to earnings a number of of 18.5x on the excessive finish primarily based on  present charges and different “macro inputs” such as inflation and progress, in response to the report. 

“18-19x is pushing the fair value limits unless we get a more aggressive slowing in inflation, noticeably lower rates, coupled with other more sanguine macro readouts,” the analysts stated.

The chart under exhibits Citi’s honest worth vary for the S&P 500 versus the index’s trailing price-to-earnings multiples since 2021.


Pointing to current consumer conversations, Citi analysts stated there’s “very little conviction that interest rates are poised to fall much further below current levels.” That’s “aligned with a view that the Fed is unlikely to move from hawkish to dovish over any shorter time frame.”

The Federal Reserve has been quickly elevating rates of interest to fight excessive inflation, with many buyers anticipating the Fed to probably pause its charge hikes this 12 months as the elevated value of residing within the U.S. exhibits indicators of easing.

As charges rose final 12 months, the S&P 500 tanked 19.4% in its worst efficiency since 2008.

“We are left with conviction in our ongoing view that rate-driven valuation headwinds may persist, implying greater importance on earnings trajectories,” the Citi analysts stated.

“Sell-side consensus seems coalescing around a weak first half, strong second half narrative,” they wrote. “We are more constructive on the second half like many of our peers, but we do not see the same downside pressure to earnings, and upside lift from valuations that others expect.”

The analysts stated that “this could hinder upside momentum” primarily based on their expectation for a decline this 12 months within the S&P 500’s earnings per share.

U.S. shares have been buying and selling combined Tuesday afternoon as buyers digested fourth-quarter earnings outcomes from Goldman Sachs Group Inc.
and Morgan Stanley. Morgan Stanley
which beat earnings estimates, was the highest performer within the S&P 500 on Tuesday afternoon with a acquire of greater than 7%, in response to FactSet knowledge, ultimately verify. 

Read: Goldman Sachs misses its earnings estimate, whereas Morgan Stanley beats as income drop

As for different main U.S. stock-market benchmarks, the technology-heavy Nasdaq Composite
was up 0.1% in Tuesday afternoon buying and selling whereas the Dow Jones Industrial Average
fell 1.1%, in response to FactSet knowledge, ultimately verify.

“We estimate that 28% of the current S&P 500 value is based on future earnings growth, which is in line with longer-term averages,” the Citi analysts stated. “We suspect earnings will be more resilient than feared.”

While Citi’s year-end goal of 4,000 for the S&P 500 is under the median strategist expectation, its estimate for the index to see earnings per share of $216 is “above peers,” they wrote. “Said differently, we expect a market multiple closer to 18x at year-end versus others around 20x.”

Read: Small-cap shares outperform to this point in 2023 as U.S. equities e-book second week of positive aspects this 12 months

Also see: ‘A year of two halves’: Stifel’s Barry Bannister expects a near-term rally in U.S. shares — and bother later in 2023

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