S&P 500 Pullback Forecasts

Investing.com — The pullback in the S&P 500 may have already started, with the index potentially retreating by 5-10%, according to RBC Capital Markets strategists.

The investment bank cites several factors for the expected retreat in the S&P 500, including:
– Stretched valuations
– Positioning in futures markets
– A recent history of bullish sentiment

These elements have historically preceded similar market downturns since late 2022.

RBC notes that while the S&P 500 and Russell 2000 indices still had some room for growth according to their models, that capacity was limited.

Additionally, weekly CFTC data suggested an overextended position in US equities futures. The AAII net bullishness, a sentiment indicator, remained above its long-term average in early October, indicating an overbought market.

The recent surge in 10-year Treasury yields, along with inflation and deficit concerns, has also unsettled investors.

"While US equities can usually weather increases in 10-year yields of 250 basis points or less, last fall's surge to nearly 5% (in line with peaks seen right before the GFC) triggered meaningful pullbacks in US equities," the strategists noted.

RBC highlighted a valuation model showing the earnings yield gap for the S&P 500 turning negative, which could predict a decline if the 10-year yield continues to rise.

Furthermore, investor concerns were exacerbated by tempered expectations for Federal Reserve rate cuts and a strengthening US dollar, leading to potential downward revisions in earnings per share (EPS) estimates across sectors.

"This is something to keep an eye on as a potential source of disappointment in the upcoming reporting season," strategists point out.

Despite these risks, strategists do not anticipate the pullback exceeding 10%, as larger declines are typically associated with growth scares or recessions.

Positive GDP forecasts for 2024 and 2025, along with favorable US economic surprises, provide some reassurance against a more substantial downturn. A 10% decline would take the S&P 500 to approximately 5,400, aligning with RBC’s trailing price-to-earnings (P/E) model’s year-end target, assuming consensus forecasts for inflation, the Fed, and 10-year yields remain valid.