The earnings recession that many said would go away is here to stay. In fact, it's getting longer and deeper as you can see in the growth chart I show in the video that accompanies this article.
And that means stock prices will still have to correct lower to wring out the excesses. To understand this, it helps to apply some simple math to the market's valuation.
The consensus estimate for S&P 500 aggregate EPS this year is slipping quickly toward $120. At S&P 1900, that means the market is trading at nearly 16 times forward earnings projections.
In a strong bull market where estimates are rising, the economy is humming, and broad stock averages continue to make new highs, paying 16X forward is not considered unusual. It's even a strategy that works when all those tailwinds, plus favorable Fed monetary policy, are in place.
Welcome to the Valuation Re-Set
But right now, none of those four drivers is a tailwind, and at least two are actually headwinds. The two that are headwinds are earnings estimates and the market averages in deep corrections, with the NYSE Composite and the Russell 2000 actually having been in bear market territory recently, down over 20%.
And neither the manufacturing slide nor the Fed raising interest rates can be considered helpful to the economy or earnings right now.
To see what you can expect from the stock market during an earnings recession, be sure to watch the video that accompanies this article. I show a great chart from Keith McCullough of research firm Hedgeye that explains how much the market typically corrects following 2+ quarters of negative earnings "growth."
I also share my view of how cheap or expensive the market is and where you should prepare to be a buyer in this big "valuation re-set" that will give long-term investors fantastic opportunities to pick up great bargains very soon.
Kevin Cook is a Senior Stock Strategist at Zacks Investment Research where he runs the Tactical Trader portfolio.