A market signal with a perfect track record says the bottom is not in, Bank of America claims
Stocks still have further to fall, especially going off one key indicator, according to Savita Subramanian of Bank of America. The Rule of 20 is one of the signposts that Subramanian watches to gauge a market bottom. The rule, which is the sum of year over year consumer price inflation plus trailing price-to-earnings has been lower than 20 at previous market bottoms, according to a Wednesday note. Currently, this number is 28.5, according to Bank of America. Bringing it down below 20 would require inflation to dramatically fall or for stocks to see a significant decline (pushing down their P/E ratio) or for earnings to grow exponentially. “Outside of inflation falling to 0%, or the S & P 500 falling to 2500, an earnings surprise of 50% would be required to satisfy the Rule of 20, while consensus is forecasting an aggressive and we think unachievable 8% growth rate in 2023 already,” Subramanian wrote. Other indicators Beyond the Rule of 20, which has a perfect track record, only 30% of the indicators that Bank of America tracks to signal a bull market have flashed green. In previous market bottoms, at least 80% of those signposts have been triggered. Other milestones that have not yet tripped include the Fed cutting rates, rising unemployment and a more than 50 basis-point decline in the 2-year U.S. Treasury yield. Just as worrisome for the bulls is that stocks are now relatively expensive given the S & P 500’s 17% rally from the June low. Still, the summer advance is probably only a bear market bounce, according to Bank of America. Bank of America sees only a 20% chance that a recession is priced in to the market, when gauging the equity risk premium. That’s down from a 36% chance in June and a 75% chance in March. Though markets seem to be betting on a soft landing, it may be too early to discount a hard one. Given this backdrop, Bank of America says investors should buy energy and industrial stocks and offload shares of consumer staples and consumer discretionary companies.