'Simply ludicrous': Wall Street's most bearish stock strategist says eye-bleeding valuations are just one factor that could send the market spiraling lower in 2020
- Peter Cecchini, global chief market strategist at Cantor Fitzgerald, makes a compelling case for a market swoon in 2020.
- Cecchini cites poor earnings quality, stretched valuations, and a plethora of other negative variables to back his thesis.
- He also says "we believe a recession in the second half of 2020 is now a possibility worthy of discussion."
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Tension on Wall Street is palpable.
Talks of war, recession fears, and uncertainty around the 2020 election aren't exactly helping the cause either.
Still, despite this backdrop, the path of least resistance seems to be higher. After all, the S&P 500 closed out 2019 with a 29% while eclipsing new all-time highs. And according to age-old Wall Street folklore, the trend is your friend.
But not all have adopted sanguine prognostications for 2020.
"The S&P 500 at 3,200 and trading at its current multiple is simply ludicrous," said Peter Cecchini, global chief market strategist at Cantor Fitzgerald in a recent client note. "In our view, long rates and US equities are reading from different sheets of music.
He added: "Some would argue equities are justifiably priced precisely because of these low long yields. We disagree."
To Cecchini, low yields don't justify high stock valuations. He actually argues the opposite. In his mind, yields are low because growth is - and he argues that a low-growth environment isn't necessarily conducive to higher stock prices.
"Multiple expansion and buybacks have driven earnings and earnings quality is poor," he said. "Looking at pretax domestic profits as measured by the Bureau of Economic Analysis, profits are down 13% in five years, akin to the pre-2001 period."
The chart below shows earnings projections for the S&P 500 from March of 2018.
The crux of Cecchini's argument is that earnings aren't growing organically. He says they're instead being artificially propped up by buybacks, and that growth is being replaced by a reduction in share count.
And then there's the matter of valuations, which Cecchini thinks have taken a backseat to less precise forces.
"While always important, sentiment is now the primary driver of equity market performance," he said.
Cecchini isn't alone in his views either. Earlier in the week Wharton School professor, Jeremy Siegel, expressed similar angst when he said: "I'm just a little worried that this is becoming a momentum-driven market at this point," adding "You don't know how far it will go."
The chart below shows a chart cited by Cecchini, showing the ratio between enterprise value of S&P 500 companies and trailing 12-month earnings before interest, taxes, depreciation, and amortization. It's currently at levels only seen at the height of the dotcom bubble.
Cantor Fitzgerald"Presently, both conventional and less conventional valuation metrics suggest that valuation (and thus sentiment) is extreme," he said. "Whether a recession is imminent or not, the risk- reward to US large cap equities seems poor."
To that end, Cecchini says investors piling in at this stage in the game are risking a lot to make a little.
Going beyond subpar earnings and extreme valuations, Cecchini relayed a plethora of headwinds that market bulls will have to weather going forward:
- "Monetary policy has largely reached the end of a secular trend"
- "The effectiveness of policy - including QE in Japan and Europe - has dwindled"
- "The Fed has hard choices it will be loath to make (like more QE)"
- "Imminent fiscal policy action is unlikely (in the US or Europe)"
- "U.S. job creation has been low quality; thus, productivity gains are unlikely"
- "The trade dispute remains on a 'long march' and optics ultimately won't suffice"
- "The progression in rates markets continues to sing risk-off"
With all of that under consideration, Cecchini shares his specific forecast for 2020.
"Thus, despite eager central banks, we believe a recession in the second half of 2020 is now a possibility worthy of discussion," he concluded. "Using our base case multiple of 17.7x and our base case earnings of $163, our S&P drawdown target becomes 2,880."
That's a roughly 12% drop from current levels.