The triangle of discount rate, growth and margins
Equities have three dominant drivers of valuation with the discount rate being the biggest influencer of equity declines over the past year. Margins are clearly rolling over in recent earnings seasons as wage pressures and commodity prices are squeezing companies’ ability to pass on all of the costs. That means that the only opposite force to lift equities has been revenue growth expectations which are directly linked to the probability of a recession. The recent rally in equities has been linked to the ‘soft landing’ narrative as economic data are suggesting the economy is growing at trend growth despite tighter financial conditions.
But with Powell’s statement about the window is narrowing for a soft landing and higher terminal rate the equity market will soon be under pressure from both higher discount rate, lower revenue expectations, and margins rolling over. Our medium term outlook of the S&P 500 hitting the drawdown cycle low at the 3,200 level is still our base case scenario.