The S&P 500 could dip below the 5000 threshold if macroeconomic pressures, most notably high inflation, continue to persist, RBC Capital Markets analysts said in a Monday note.
In their report, the investment bank stresses that the market’s current price-to-earnings (P/E) ratio could decrease under prolonged inflationary pressures and a lack of anticipated interest rate cuts by the Federal Reserve.
RBC's base model, which leverages consensus forecasts on economic variables, suggests that the S&P 500 should trade at around 21.5x earnings by the end of 2024, potentially placing the index at 5100 to 5300 if their earnings per share (EPS) forecast of $237 for 2024 is accurate.
However, in a stress test scenario considering no Fed rate cuts, higher-than-expected inflation, and 10-year Treasury yields not rising above 5%, the P/E ratio could drop to 20.8x, pushing the S&P 500 down to a range of 4900-5100.
In another stress test, where inflation exceeds 3% and the 10-year yield rises to 5.5%, the trailing P/E retreats to 19.1x “and points to about 4,500 for fair value for the S&P 500 on our EPS forecast and the 4,600-4,700 range using consensus EPS,” RBC strategists said in a note.
Meanwhile, RBC also reflected on the latest performance of small caps versus large caps.
Small caps, as measured by the Russell 2000, have been retesting their relative lows compared to the S&P 500, the investment bank notes.
Despite a brief rally driven by Fed rate cut optimism in early May, small caps have struggled, with only 62% of Russell 2000 companies beating consensus estimates in the recent reporting season, compared to 77% for the S&P 500.