Feeling Disconnected

Mid-Month Stretch: May 2022

Over the month, we digest a plethora of economic and market data. Sorting through what is relevant can be a challenge and must be viewed within the context of the current environment.

It's often said, a picture is worth a thousand words, so for the Mid-Month Stretch, we decided to highlight a handful of charts that caught our eye and help illustrate what has been driving the market.

I Feel a Little Disconnected, Nothing that Can't Be Corrected

Equity markets feel a little disconnected from corporate earnings, but we know investors are adjusting to a higher interest rate environment.

Despite equity markets struggling, full-year 2022 earnings growth has improved year to date – from an estimated 9.2% as of December 31, 2021, to 10% as of May 13, 2022. Not only do we see an improved earnings trajectory for the broader index, but as you can see in the second chart below (More Upgrades than Downgrades), the number of earnings upgrades far exceeded downgrades (279 versus 178).

So why are markets struggling? There is a direct correlation between rates and what investors are willing to pay for future earnings. The higher rates go (to fight inflation), the less inclined investors are to pay a higher price (P) for future profits (E).

Said another way, the price-to-earnings (P/E) multiple contracts when interest rates are increasing.

We can see this dynamic occurring in the housing market. All else being equal, higher mortgage rates will put downward pressure on housing prices (unless you're living in Vancouver or Toronto 😊).

S&P 500 Earnings Estimates Moving in the Right Direction

More Upgrades than Downgrades

Don't Go Get Sentimental on Me

Rising rates, China shutdowns, supply chain issues, Russian/Ukraine war, spiking commodity prices…you get the point.

There is no shortage of things to worry about, and the market is worried. In the short term, the "extreme fear" sentiment can provide an opportunity to put cash to work.

CNN Fear and Greed Index

Investor sentiment is so poor that institutional cash levels have risen to the highest level since 9/11, according to Bank of America's Fund Manager Survey (FMS). When everyone is bearish, this is typically a good time to start scaling into the market.

During the financial crisis, cash levels peaked in December 2008, the market bottomed in March 2009.

During the COVID sell-off, cash levels peaked in April, one month after the market low in March 2020.

Warren Buffett once said that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.”

Fund managers are raising cash levels amid their gloomy outlook for corporate profits. In fact, managers haven’t been this gloomy about corporate profits since 2008!

We find this comparison striking considering the global economy was on the brink of financial ruin back in 2008. It's hard to imagine we're in the same dire situation today as we were nearly 15 years ago.

The Price is Right; Come on Down!

Interest rates are moving higher due to solid demand and inflationary pressures. The trajectory of interest rates will be a function of how inflation evolves over the next several quarters. Our base case is for inflationary pressures to ease, allowing the pace of rate hikes to slow.

To put the current inflation in perspective, we remind readers that the US has undershot its inflation target for the past decade. In recent years, the US Federal Reserve moved to inflation averaging, rather than a target, meaning they will likely allow inflation to run hot to make up for the past decade.

Inflation Returned to Trend

Two Steps Forward, One Step Back

It's been a challenging start to the year, but the silver lining is history suggests brighter days are ahead, assuming the US economy doesn't slip into recession. Looking at past similar declines in the S&P 500, the index finished higher 92% of the time one year later.

S&P 500 Performance After 15% Drawdown


Implementation of a thoughtful investment strategy that can minimize downside risks during challenging markets.

While we raise cash levels during periods of stress, the importance of staying invested is critical in generating significant long-term wealth.

Why is it important to stay invested? Over the last 20 years, if you had missed the ten best trading days, you would have significantly underperformed the market, and if you missed the best 20 days, your annualized return would be a big fat zero.

It's time in the market, not timing the market, that generates long-term wealth.

Valuation levels on broader market indices, such as the S&P 500, are approaching levels that we'd view as attractive (currently, a price-to-earnings multiple of 16.6x is trading below the 10-year average).

S&P 500 Price-to-Earnings Multiple Looking more Attractive

However, US small caps appear ridiculously cheap compared to their US large caps peers. In fact, you'd need to go back to the early 2000s to find a similar discount.

Small-Caps Trading at a BIG Discount to Large-Cap Stocks

The Ties That "Bond"

Bonds haven't offered much protection year to date, pressured by the rapid increase in rates and inflation. Bruce Springsteen wrote, "You been hurt and you're all cried out you say", well there are plenty of bond managers with tear ducts as dry as the Sahara desert.

Generally, bonds and equities move in opposite directions, which helps smooth volatility in a portfolio that holds both asset classes. However, year to date, bonds and stocks are moving together, temporarily offsetting the benefit of asset class diversification.

Stocks and Bond Moving in the Same Direction

How tough a year has it been for bond investors? This year's drawdown is the second largest in the history of the bond market. Though, like equities, bonds look more attractive and potentially undervalued.

Tough Year for Bonds

Bonus Charts

When did you get your first phone?

No, not that one. This one. Smartphone adoption among children at different ages.

Netflix has a mooching problem.

If there were only one service that would let me watch all my shows from one device…oh wait, wasn't that called TV!



This newsletter has been prepared by the Cadence Financial Group and expresses the opinions of the authors and not necessarily those of Raymond James Ltd. (RJL). Statistics, factual data and other information are from sources RJL believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. This newsletter is intended for distribution only in those jurisdictions where RJL and the author are registered. Securities-related products and services are offered through Raymond James Ltd., member-Canadian Investor Protection Fund. Insurance products and services are offered through Raymond James Financial Planning Ltd., which is not a member-Canadian Investor Protection Fund. This provides links to other Internet sites for the convenience of users. Raymond James Ltd. is not responsible for the availability or content of these external sites, nor does Raymond James Ltd endorse, warrant or guarantee the products, services or information described or offered at these other Internet sites. Users cannot assume that the external sites will abide by the same privacy policy which Raymond James Ltd adheres to. Recommendation of the above investments would only be made after a personal review of an individual’s financial objectives. Securities-related products and services are offered through Raymond James Ltd. Insurance products and services are offered through Raymond James Financial Planning Ltd.

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