These Economic Indicators Say Stocks Have Further to Fall

One of the biggest questions investors want to know is whether or not the stock market has bottomed and if the recent run on stocks will hold. As per usual, it depends on who you ask, there will always be perma-bears and bulls. But there are reliable economic indicators that suggest stocks still have further to fall.

Has the Stock Market Bottomed?

Stocks entered 2022 on a bullish note with the S&P 500 hitting a new record high of 4818.62 on January 4. But surging inflation, rising interest rates, fears of a recession, supply chain issues, and, at the time, concerns that Russia might invade Ukraine cobbled the bull-run.

By mid-June the S&P 500 had tumbled approximately 25%. Stocks have rallied since then, with the S&P 500 up 12%. While the index still needs to climb an additional 18% to get to its previous highs, many investors are hoping the June bottom will hold.

Jim Cramer, the bombastic television personality and host of Mad Money, believes the bear market has bottomed and pointed to the 10-year Treasury yield and price of oil as evidence.

Others meanwhile point to economic indicators, including the Rule of 20, that say the stock market has further to fall.

What Is the Rule of 20?

The Rule of 20 says the stock market has not bottomed. The rule states that a new U.S. bull market starts when the sum of the trailing price to earnings (PE) ratio of the S&P 500 and inflation rate result in a number of less than 20.

We’re nowhere near that right now. The trailing PE ratio is 20.65 and the inflation rate is 8.5, for a total of 29.15. To get to 20, inflation would need to fall to 0% or the S&P 500 would need to fall 40% to 2500, or Wall Street would need to announce an earnings surprise of 50%.

So far, the Rule of 20 has a perfect track record when it comes to U.S. stocks in that the markets have never hit a bottom when the PE ratio and inflation have combined for a value of above 20.

There are other indicators that point to additional pain on Wall Street and Bay Street, including investor sentiment, the fact that the Federal Reserve has said it will continue to announce big rate hikes, and the yield curve.

On top of that, the Case Schiller CAPE/PE Ratio is sitting at 30.57; that’s 91% higher than its historical average of 16. That means that for every $1.00 of earnings a company makes, investors are willing to pay $30.75. The index has only been higher once, in 2000.

The fact is that valuations remain high at a time when economic growth is slowing. This could lead to lower earnings and increased volatility over the coming quarters.

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The stock market is down 15% in 2022 but valuations are still exceptionally high which suggests the stock market hasn’t bottomed yet. That doesn’t mean it will fall, but history suggests it hasn’t yet bottomed. The trading experts at Learn-To-Trade.com understand that even if Canadian and U.S. stocks do trend lower, there are always equities that will buck the downtrend.

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