Valuation Concerns Creeping in to Drive a Cooldown Phase

The stock market is on track to start today’s session with a negative slant, continuing the action seen Friday following the much stronger-than-expected January employment report and ISM Services PMI.

Currently, the S&P 500 futures are down 31 points and are trading 0.8% below fair value, the Nasdaq 100 futures are down 124 points and are trading 0.9% below fair value, and the Dow Jones Industrial Average futures are down 180 points and are trading 0.5% below fair value.

Those indications are improved from earlier but not enough to ensure a start in positive territory for the cash indices.

That’s not altogether surprising. Last week was a good week for the stock market, like most weeks have been so far in 2023, yet last week also featured some nonsensical price action in many stocks that revealed a heightened degree of speculation and a stoked a palpable sense of complacency that seems misaligned with a deteriorating earnings backdrop.

As discussed in The Big Picture column posted Friday, the market’s valuation at 18.5x forward twelve-month earnings is full, if not rich, knowing that earnings estimates are still declining. To wit: the forward twelve-month EPS estimate stood at $229.30 when the year began and is currently at $225.36, according to FactSet.

Therefore, valuation concerns appear to be creeping in to explain some of this morning’s softness, but something else that has crept back into the mix following the employment report is the specter of the Fed having more room to raise rates and to leave them higher for longer.

Last Thursday, the CME FedWatch Tool showed only a 30% probability of a third, 25-basis point rate hike at the May meeting. Today, however, the probability has risen to 70.9%, which is up from 61.8% on Friday.

In turn, the 2-yr note yield, which was at 4.10% last Thursday, is up to 4.42% today.

The bump in Treasury yields, driven by some shifting in rate-hike expectations, is slowing the stock market’s upside momentum. Increased geopolitical tension between the U.S. and China, after the U.S. shot down a suspected Chinese spy balloon off the coast of South Carolina over the weekend, has also been cited as a restricting factor this morning.

Still, our intuition tells us that the equity futures would have been leaning negative this morning even if there wasn’t a spy balloon incident. That’s because market participants know that things are running too hot in the stock market and that many of the stocks that have gone parabolic need to cool down a bit (and perhaps a lot more than a bit).

Life Storage, Inc. (LSI) and Catalent (CTLT), however, are both running hot at the moment. The former received an $11 billion all-stock buyout offer from Public Storage (PSA), whereas the latter has reportedly drawn Danaher’s (DHR) takeover interest, according to Bloomberg.

In related M&A news, Newmont Mining (NEM) has confirmed a proposal to combine with Newcrest in a $17 billion deal.

This M&A activity hasn’t altered the pre-market disposition for a couple of reasons. First, the deal sizes aren’t that significant to be labeled market moving, and, secondly, the market has some good reasons to take a breather.

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Originally Posted February 6, 2023 – Valuation concerns creeping in to drive a cooldown phase