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 as to why the S&P 500 could retreat, including stretched valuations, positioning in futures markets, and 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 not significant.
In addition, the weekly CFTC data suggested an overextended position in US equities futures, and the AAII net bullishness, a sentiment indicator, was repeatedly 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 spooked investors.
“While US equities can usually weather increases in 10 year-yields of 250 basis points or less, that last fall’s move to nearly 5% (in line with peaks seen right before the GFC) was enough to trigger a meaningful pullback in US equities,” strategists said in the note.
RBC also 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 rises further.
Moreover, investor concerns were fueled by tempered expectations for Federal Reserve rate cuts and a strengthening US dollar, which could lead to downward earnings per share (EPS) estimate revisions in several sectors.
“This is something to keep an eye on as a potential source of disappointment in the next reporting season,” strategists point out.
Despite these risks, strategists do not see 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 around 5,400, which aligns 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 hold true.