As of early February, 31% of stocks in the S&P 500 were down 30% or more from their 52-week highs, Citigroup says, close to the figure seen in market selloffs of 2011 and 2012, but well below the 80% figure in the 2008 tumble ahead of the economic slump. This has a strong gravitational force on the broader market with any bad news. However, U.S. stocks have reached over sold levels across many sectors as seen in the chart below which shows the price/earnings(P/E) multiples of the S&P sectors. Many sectors are now at a discount to the historical mean P/E.
With the S&P 500 and DJIA both down near 15% from their highs last fall, it makes sense to monitor relative valuations to determine how much downside risk remains in the stock market. While stocks are becoming more fairly valued, a catalyst will be needed to spark a sustained rally. We have gotten to these levels with weakening corporate earnings, a strong dollar, tightening credit and a bias in Fed policy toward raising rates. High correlation with the price of oil suggests that one catalyst could be an agreement by OPEC to pause production. As we have previously written, the supply/demand imbalance is being questioned. A demand driven glut could indicate wide reaching global economic weakness. A supply side glut should be cured as price leads to consolidation and forces producers out of the market.
While risks of a recession are elevated, asset prices may already be reflecting these risks. One measure is the relative valuation of asset prices to past cycles. Another measure is investor sentiment. Bloomberg reported this week that the BAML Global fund manager survey for February shows cash levels at 5.6%, the highest level since Nov. 2001, an ’unambiguous buy signal’ BofAML strategists write in note.