Year-to-date, the S&P 500 is up 8%. But in a note to clients on Friday, Lynch warned that the index is due to weaken in the near future with a recession on the horizon. He said it would return to levels near October 2022 lows of 3,491, which would represent 15% downside from current levels around 4,130.
Lynch sees several factors lining up to work against stocks. At the top of his list is the pullback in earnings he expects. "To be sure, inflation has come down from its 9.0% YOY peak last year, and the recent March CPI report showed a 5.0% YOY gain. Data since 1970 shows that in previous periods when inflation hovered at these levels, the S&P 500's P/E was just 15.5 times earnings, suggesting current equity prices may run into resistance until either earnings climb or stocks drop," Lynch said.When looking at stock valuations relative to bond yields, they also remain at historically high levels.
"The ERP is calculated by taking the earnings yield, which represents the inverse of the S&P 500's P/E ratio and subtracting the yield on the benchmark 10-year U.S. Treasury note," Lynch said."For example, at the current S&P 500 P/E of 19, the earnings yield for stocks is 1 divided by 19, or ~5.2%.
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