News & analysis
SocGen Flags Stretched Valuations, Narrow Breadth as Fed Tightening Risk Builds
The bank's strategists see equity multiples still rich against bonds, a market leaning on a handful of names, and a tightening cycle that has ended in recession in most past instances.
Key points
- SocGen says stocks still look expensive versus bonds despite recent PE de-rating, with valuations supported by trailing earnings pushed far into the future
- The bank warns breadth is deteriorating rapidly, with technical measures showing the market owes much to very few names
- SocGen notes a Fed tightening cycle has started and has ended in recession in 11 of 14 past instances
Equity valuations remain stretched relative to bonds even after a recent de-rating in price-to-earnings multiples, according to a SocGen assessment that also flags deteriorating market breadth and the risk that the Federal Reserve is behind the curve on inflation.
The bank's strategists argue that current multiples are sustained by blockbuster trailing earnings that have been extrapolated well into the future, leaving little room for disappointment. Despite the recent de-rating, equities have not become cheap relative to fixed income, keeping the valuation gap that has defined the bull market largely intact.
Breadth is the second pillar of the warning. SocGen describes technical measures of market participation as deteriorating rapidly, with the advance concentrated in a shrinking group of stocks. The bank's summary of the dynamic is blunt: never have stocks owed so much to so few.
On policy, SocGen notes a tightening cycle has already started and points out that 11 of the last 14 such cycles ended in recession. The biggest risk the bank identifies is that the Fed discovers, or comes to believe, it is behind the curve, forcing a more aggressive response than markets currently expect.
The bank also raises the question of whether profits-led inflation, sometimes called greedflation, is again a problem. It notes that despite soaring energy costs, total unit costs look moderate, but argues that companies, as in 2022, are taking advantage of the environment to boost profits through prices.
SocGen's conclusion is that the technicals deserve close attention for signs of a breakdown. The combination of rich valuations, narrow leadership and a Fed tightening into an uncertain inflation backdrop leaves the market vulnerable if participation continues to thin.
