Stock Market Re-Rating to Lower Valuation

Stocks surged at the open this morning, reversing yesterday’s declines. At the moment, the Dow is up 400 points and the S&P 500 is up 1.3%. Nine of eleven major market sectors are the in the green, led by financials (+1.8%) and technology (+1.5%). Only utilities and real estate are struggling, and that clearly points to rising interest rates. Commodities are mixed in early trading. While crude oil quietly climbed to 7-year highs over the last week, gold has struggled. In fact, gold is down about 3% over the past month. Gold is often thought of as a hedge for inflation, and inflation is clearly higher than normal. But when inflation comes about because of strong economic growth, gold doesn’t do so well. The bond market is mostly lower today as rates back up. The iShares 20+ Year Treasury Bond fund (TLT) is down 1% today. The iBoxx Investment Grade Corporate Bond fund (LQD) is down .4% in early trading.

According to Bloomberg News, bonds are down on “optimism in the economy’s strength.” Private research firm IHS Markit released monthly data suggesting both manufacturing and service sector business activity accelerated in September. A separate report from the Institute for Supply Management (ISM) corroborated that optimism with an extremely high reading on its service sector business activity index.

At its worst, the S&P 500’s correction reached -5.9% yesterday compared with its intraday record high on September 2^nd. Small-caps have fared slightly better, while technology and emerging markets indexes have done a bit worse. Both value and growth are correcting. The point is, nearly all of the equity landscape is a bit lower. And that makes sense. Interest rates are again drifting higher so stock valuations should settle. The 10-year Treasury Note yield, considered the risk-free interest for investors, recently backed up to 1.53% and could reasonably continue toward 1.75% (the 2021 high) in the near-term. Many investors look to the Price/Earnings ratio to gauge how expensive stocks are. The P/E (using expected earnings over the next year) on the S&P 500 has fallen to 20.4 from 21.9 over the past month. That’s the lowest level in nearly a year, and might signal that investors believe higher inflation could be with us for longer than the Federal Reserve expects.

Merck (MRK) says it has developed an antiviral Covid pill that works. The experimental drug, molnupiravir, apparently cut the risk of hospitalization or death by about 50% for patients with mild or moderate Covid cases. The company’s phase 3 clinical trial included only those who were unvaccinated and had at least one pre-existing health factor that put them at greater risk of severe Covid infection. Merck will now apply for FDA emergency use authorization for the drug.