- A new bull market for stocks won’t commence until the Fed stops hiking interest rates, according to DataTrek Research said.
- Additionally, investors need to have confidence in earnings expectations heading into a potential recession.
- “It is hard to imagine volatility declining until we get clarity on Fed policy and corporate earnings power,” DataTrek said.
Investors shouldn’t expect a bull market to return for stocks until volatility declines, according to a Thursday note from DataTrek Research.
Unfortunately, investors shouldn’t expect volatility to decline until two things happen: The Federal Reserve stops hiking interest rates, and there’s more clarity on corporate earnings expectations heading into a potential recession next year.
If investors can properly gauge those two factors, and ultimately anticipate the transition from a high volatility regime to a low volatility one, then they can capitalize off extreme stock market returns.
Prior examples of market transitions include the S&P 500’s 28% surge in 2003 after the dot-com bubble, the 26% gain in 2009 after the Great Financial Crisis, and the 61% gain from the COVID-19 low through the end of 2020.
“For volatility to structurally decline and drive those high returns, investors need to have growing confidence they know how corporate earnings will develop. This means they mush have a handle on monetary/fiscal policy,” DataTrek co-founder Nicholas Colas said.
And right now, investors are unsure about both factors. The Fed caught the market by surprise last week when it indicated that it will likely raise interest rates by another 75 basis points in 2023 and leave rates higher for longer. And the Fed’s timeline could change on a dime if inflation remains persistently high.
On the earnings front, analyst estimates are all over the place, and so are expectations of whether the economy will enter a recession or not.
According to data from Bloomberg, the average and median earnings per share estimate for the S&P 500 in 2023 is $210, but the low and high estimates make for a pretty sizable range. The high estimate is for $230 in S&P 500 EPS, while the low estimate is down to $186.
It’s normal to have such a wide range in estimates because stocks are currently in a bear market, and during a bear market, uncertainty is high, earnings visibility is low, and fear of a recession is common due to various macro factors, Colas explained.
And not until volatility declines and the Fed stops hiking interest rates will investors have a better handle on corporate earnings visibility, according to the note.
“During the subsequent economic expansion corporate earnings become much more predictable, as does Federal Reserve monetary policy. These are bull markets,” Colas said.
And while investors will continue to attempt to anticipate the turn in volatility and call a bottom in markets, “all we know for sure, based on the data, is that it will be more important to get and stay long US stocks in the months and years after volatility diminishes and the next rally is underway,” Colas said.