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Moving to the phase where bad news becomes good news

November 21, 2022

The likelihood of the delivery of sustained disinflation in 2023

Market Navigation

Despite persistent fears that financial conditions are sufficiently restrictive to cause a slowdown next year, the positive market reaction to the weaker than expected October CPI data seemed to indicate a transition to a new phase of inflation dynamic analysis - the likelihood of the delivery of sustained disinflation in 2023.

Bad economic news feeds this narrative and therefore could now be seen as good news.

Chart 1: On the cusp of phase 3 of inflation analysis

 Source: Wilshire, Refinitiv. Data as of November 15, 2022

Intensified focus on the Fed’s disinflation forecast for 2023

Chart 1 plots the progression of the Fed’s core PCE inflation indicator. The twelve month period between February 2021 and February 2022 saw the inflation rate almost triple, generating the hawkish tilt by the Fed. Since then, the inflation rate has plateaued (albeit at an elevated level).

The focus now turns to the plausibility of inflation moving sequentially lower next year as predicted by the Fed. Their current forecast of year-end 2023 inflation reaching 3.1% requires a monthly run rate of 0.3%. A run rate of 0.2% a month would deliver a 2.4%-year end inflation level.

Forward looking indicators such as the ISM prices paid index point to continued downward pressure on headline inflation in the coming months.

Chart2:  The ISM manufacturing prices paid index points to lower US CPI  

 Source: Wilshire, Refinitiv. Data as of November 15, 2022



Perception that inflation could be peaking and then encountering disinflationary headwinds (after the October CPI report) produced a downward shift in the US interest rate curve as can be seen in Chart 3.

Any further signs of weakness in final demand (bad news) could now be the catalyst for continued downward shifts in the interest rate curve (good news).


Chart 3: US market rate expectations fell after the lower-than-expected US CPI numbers



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Unpacking the drivers behind the deteriorating US EPS growth trajectory

November 21, 2022

The second half of 2023 has seen the 2023 EPS growth rate forecast start to decline

Market Navigation

As can be seen in Chart 1, the second half of 2023 has seen the 2023 EPS growth rate forecast start to decline. This has clearly been connected to the rapidity of the commensurate decline in forward looking GDP growth forecasts.

Chart 1: 2023 EPS growth forecasts have followed GDP forecasts lower

Source: Wilshire and FactSet. Data as of November 15, 2022

Technology and Health Sectors have been the key drivers behind the downgrading

Chart 2 shows the sector weighted contribution to the aggregate 2023 market EPS growth rate. In May the forecast was for 12% EPS growth, and this has now declined to 7.9%. The main contributors to this 4.1% decline were the negative contributions from the tech and health sectors.

Chart 2: Comparing the US vs World ex US PE ratio moves over the last 20 years

Source: Wilshire and FactSet. Data as of November 15, 2022

There is a lot of seasonality built into the 2023 EPS projections

Chart 3 shows the progression of quarterly US EPS forecasts out to the end of 2023, with the blue bars showing the Q/Q growth rates and the grey line showing the quarterly forecast EPS (USD). As the chart shows, there is high levels of seasonality forecast over the next 12 months or so.

After flat or negative EPS growth expected for the next three quarters, a lot appears to be hinging on a recovery in EPS in Q3 and Q4 of next year.


Chart 3: A lot is riding on the delivery of a positive EPS inflection in Q3 2023

Source: Wilshire and FactSet. Data as of November 15, 2022

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The scale of the de-rating has pushed PEs back to Covid lows

October 21, 2022

Scale of the drawdown in global equities in 2022 has produced a significant de-rating with US equites experiencing one of the largest PE contractions

Market Navigation

The US has experienced one of the largest PE de-ratings in 2022

Chart 1 shows the status of regional 12m forward PEs, where these sat at the end of last year and the scale of the de-rating experienced so far in 2022. The UK and US have seen valuations decline by around a third, China and Europe ex UK by a quarter.

Chart 1: The scale of PE de-rating experienced across the regions in 2022

Source: Wilshire and FactSet. Data as of October 16, 2022

Putting the valuation shift into a longer perspective

Taking a longer-term view of valuations, Chart 2 shows the 12m forward PE for the US and World ex US over the past 20 years. The chart shows the sheer scale of the de-rating over the past 2 years. From its peak in September 2020 the US 12m forward PE has declined 36%, with World ex US also declining by the same quantum from its peak in July 2020. Although valuations are not far from the Covid sell-off lows, they are someway from the lows of the GFC, where the US and World ex US 12m forward Pes fell to 8.7x and 7.1x, respectively

Chart 2: Comparing the US v World ex US PE ratio moves over the last 20 years

Source: Wilshire and FactSet. Data as of October 17, 2022

The US 'fed model' (equity vs bond) valuation analysis

Chart 3 shows the Fed Model valuation (equity earnings yield minus 10-year government bond yield) since 1992 and looks at the average levels over 3 distinct periods. As we can see, although the current Fed Model valuation is below its post-GFC average, it is above the pre-GFC 2002-2008 average, and well above the negative levels experienced in the 1990s. From a Fed Model valuation standpoint, the rise in bond yields this year has partially offset the impact of the US equity market de-rating.

Chart 3: The US 'fed model' valuation looks stretched versus the last 10-year range but not versus the pre GFC period

Source: Wilshire, Refinitiv and FactSet. Data as of October 17, 2022

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Perspectives on the bear market – how long will sentiment languish at historic lows?

October 21, 2022

The FT Wilshire 5000 has experienced a technical bear market in 2022 (defined as at least a -20% drawdown)

Market Navigation

We examine the scale of the drawdown in the context of the 50-year history of the index and also look at return characteristics after reaching sentiment indicators lows.

Putting the 2022drawdown into 50-year context

Putting the 2022 drawdown into a historical context, Chart 1 shows FT Wilshire 5000 bear markets since the inception of the index in 1970, looking at the peak to trough move, as well the duration. As we can see the 2022’s bear market (so far) ranks as the seventh largest in history, and the fifth longest.

Chart 1: So far 2022 ranks as the fifth longest bear market in the FT Wilshire 5000’s history

Source: Wilshire. Data as of October 16, 2022

Sentiment indicators have reached levels last seen in the GFC of 2008-9

Chart 2 shows our US Composite Sentiment Indicator (CSI), which incorporates nine technical analysis and market breadth measures aiming to identify levels of exuberance and pessimism. As we can see, the CSI continues to languish around levels experienced during the GFC in 2008-9, when sentiment continued to remain at low levels for an extended period of time during the recession.

Chart 2: The US Composite Sentiment Indicator remains at extreme lows

Source: Wilshire, FactSet and Refinitiv. Data as of October 16, 2022

The pattern of subsequent market returns after reaching sentiment lows

Examining periods of statistically significant levels of low sentiment, Chart 3 shows that our US CSI has fallen below 2 (more than 1.5 standard deviations below the long-term average) thirteen times over the past fifteen years.  In the post GFC period, the US market has subsequently posted positive returns after the CSI falls below 2. However, we can observe this was not the case during the GFC, which was the last example of a prolonged recession.  

Chart 3: The returns delivered three months after hitting sentiment lows

Source: Wilshire, FactSet and Refinitiv. Data as of October 16, 2022

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US EPS cycle starting to wobble

September 26, 2022

After a period of relative stability, we are starting to see a deterioration in the EPS or profit cycle through the prism of estimate trail analysis

Market Navigation

US growth rate stability and downgrading in Asia Pacific and EM, however…

Chart 1 shows the status of regional consensus EPS growth forecasts for this year and next and the revisions (deltas) to the forecasts over the last month. The notable negative revisions have been in Asia Pacific and Emerging Markets. In terms of 2023 growth rate projections, the US is still predicted to deliver the highest growth rate among developed markets.

Chart 1: Regional consensus EPS growth forecasts

…Growth rates might be giving a false sense of security

Growth rate analysis does not provide insight into the status of the cycle as it simply measures the difference in EPS forecasts over two distinct time periods. If both periods see EPS decline by 10%, the growth rate remains the same. That is why EPS cycle analysis must be viewed via EPS trails that map the changes to calendar year forecasts over time. Chart 2 shows the EPS trails for the US and that after a period of stability both 2022 and 2023 EPS estimates have started to decline. The cycle seems to be deteriorating.

Chart 2: US consensus EPS trails - starting to wobble

Most sectors have seen negative EPS revisions over the last month

Chart 3 shows revisions to 2022 and 2023 EPS estimates versus the August market high for both the US and World ex US at a sector level. Energy remains the only sector to see positive revisions to 2022 and 2023 estimates for the US and World ex US.

Chart 3: A broad deterioration in sector EPS revisions

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Risk aversion being driven by tightening financial conditions

September 26, 2022

Markets have been gripped by risk aversion since mid-August

Market Navigation

Markets have been gripped by risk aversion since mid-August in response to hawkish Fed and global central bank guidance, elevated inflation, and a significant tightening in financial conditions.

Global interest rate forecasts continue to ratchet higher

Chart 1 shows the status of regional market interest rate forecasts for 2022 and 2023 as well as the respective central bank forecasts. It can be seen that except for Japan, all other regions have witnessed significant uplifts to interest rate curves over the last three months.

Chart 1: Regional consensus and central bank 2022 and 2023 interest rate forecasts

US interest rate forecasts have risen 100bp in the last month

Both the Fed dot plots and market interest forecasts have risen by 100 basis points. While the Fed forecasts point to a continued gradual increase in rates, peaking at 4.6% by the end of 2023, the market is predicting a gradual decline in rates over the course of the second half of next year.

Chart 2: US market consensus and Fed dot plot interest curves

US financial conditions are facing a perfect storm

Our Financial Conditions Indicator (FCI) is designed to reflect the impact on market risk appetite through the combined impact of related financial components. Since mid-August, the US FCI has increased and is in restrictive territory (a key driver of risk aversion). Some of the key elements pushing the FCI higher have been the rise in the USD (REER), interest rate forecasts, government and corporate bond yields and a contraction in real M2 money supply growth.

Chart 3: US financial conditions being driven higher on many fronts

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US valuations rebound from mid-June lows led by consumer durables, technology and retail sectors

August 19, 2022

US consumer durables, technology and retail have led the re-rating of the US market since mid-June

Market Navigation

After a significant PE de-rating in the first half of the year and a narrowing of valuation dispersion, US consumer durables, technology and retail have led the re-rating of the US market since mid-June.

US, Europe ex UK and Emerging Markets have seen the largest re-ratings since mid-June

Chart 1 shows the current regional 12m forward PEs, the scale of the de-rating from the start of the year to the lows in mid June and the re-rating since. Following a 30% decline in the PE from 22.5 to 15.7x in mid-June, the US has been among those to see the biggest re-ratings since, along with Emerging Markets and Europe ex UK.

Chart 1: Scale of regional PE de-ratings in the first half of the year and the recovery since mid-June

Consumer durables, technology and retail sectors have led the US re-rating

Looking into what has driven the US re-rating, Chart 2 again shows the latest 12m forward PEs and the shifts in valuations at the US sector level. As we can see, the consumer durables, retail and technology sectors have seen the largest re-ratings since mid June. These sectors saw some of the largest de-ratings in the first half of the year.

Chart 2: Status of US sector 12m forward PE and the journey traveled so far in 2022

The market sell-off in the first half of the year caused a substantial narrowing of valuation dispersion in the US

Drilling further into the dynamics within the US market, Chart 3 looks at the top quintile PE relative to the median stock PE. As we can see, the cluster of top quintile PEs has witnessed a significant relative PE expansion since mid-2017. The upshot of the market sell-off in the first half of the year, which had an outsized impact on more highly valued growth and tech stocks, is that we have seen a narrowing in the valuation dispersion between the top quintile and median stock PEs in the US, with the premium falling back toward pre-COVID levels in June. However, with the growth and tech sectors regaining market leadership since the US recovery, more recently we have seen the valuation dispersion beginning to widen again.

Chart 3: Top quintile US PE relative to the median stock PE


Source: Wilshire, Factset and Refinitiv, 10 August 2022

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US leads market recovery from the lows in mid-June after sentiment hit extreme lows

August 18, 2022

Following a record-breaking decline in the first half of 2022, markets have staged a recovery led by the US.

Market Navigation

The trough in June coincided with our US Composite Sentiment Indicator hitting, similar levels of pessimism seen during the midst of the Global Financial Crisis (GFC).

US relative performance almost back to December 2021 levels

Chart 1 shows the FT Wilshire 5000 index relative to the World ex US. After underperforming the World ex US index from the end of December through mid-June, the US has seen a big improvement in relative performance over the past two months. The recent period of outperformance has seen the US claw back most of the year-to-date underperformance, returning toward the peak levels seen at the end of 2021.

Chart 1: FT Wilshire 5000 relative to World ex US almost back to peak levels seen in December 2021

US market recovery coincides with Composite Sentiment Indicator hitting extreme lows

It was noteworthy that the rebound in the FT Wilshire5000 has coincided with sentiment hitting statistically significant levels. Chart 2 shows our US Composite Sentiment Indicator (CSI), which incorporates nine technical analysis and market breadth measures, and aims to identify levels of exuberance and pessimism. This has proven a useful market timing tool and contrarian indicator. The market rebound in June coincided with the US CSI hitting extreme levels of pessimism—over a 2.5 standard deviation move relative to a long-term average, and similar levels witnessed during the GFC. We can see that once these levels have been hit, the indicator does not stick around for long before moving higher. Should the market recovery continue, a key question will be when sentiment will approach overbought levels, at least in the short-term.

Chart 2: Our US Composite Sentiment Indicator hit extreme lows in June

Improving breadth within the US market

Looking at the breadth of the recent recovery in the markets, Chart 3 shows the percentage of stocks registering a Relative Strength Index (RSI) of over 70, which forms part of our Composite Sentiment Indicator and typically indicates an overbought signal for a stock or index. We show the latest readings versus the lows in June, as well as the five-year average level. The US has seen a fairly rapid rotation in sentiment, moving from 0% to around 16%, now at a similar reading to the peak levels we saw in December last year, and well above the five-year average. Conversely, using this measure of breadth the Chinese equity market has experienced a deterioration in sentiment over the same short period.  

Chart 3: The percentage of stocks registering an RSI of over 70 in the US has risen rapidly during the recovery

Source: Wilshire, Factset and Refinitiv, 10 August 2022

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US equity market experiences one of its largest PE de-ratings in 30 years

July 19, 2022

The scale of decline in valuations was one of the largest de-ratings witnessed in 30 years

Market Navigation

A notable feature of the market fall over the course of the first half of 2022 was the scale of valuation shift it produced.

As can be seen in Chart 1 the US and UK markets witnessed the largest proportionate decline in their PE levels comparing mid - year valuations with those as at year end 2021.The US PE valuation has fallen -26.8% from 22.5x to 16.4x over a six-month period.

Chart 1: Regional 12M PE ratios - now v levels at the end of 2021

The 6 months decline in the US PE ratio has been one of the largest in 30 years

Measuring the six month change in the market PE and comparing this to historical moves we can see in Chart 2 that the recent decline US has experienced a statistically significant (3 standard deviation) valuation correction. This is one of the largest moves over the last 30 years.

Chart 2: Measuring the 6-month change in the US 12M PE


The valuation effect was the key driver behind negative returns in 2022

Chart 3 below decomposes market return drivers into three categories - the contribution of changes to EPS forecasts, Dividends and Valuations. YTD data as at end June 2022 clearly shows the scale of performance drag delivered by the decline in PE valuations

Chart 3: YTD regional market return decomposition

PE relative analysis highlight interesting global valuation dynamics

A function of the US market experiencing a proportionately large PE de-rating is that it has seen its PE relative premium (comparing the PE of the US market to that of the World ex US market) decline from a peak of 55% in March this year to a current level of 32%.

By contrast the PE relative for Emerging Markets has moved from a c. 20% discount to parity - something last seen in 2016.

Chart 4: PE relatives comparisons

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