What to Watch

Positioning Amidst the Disconnect

2022 was all about interest rates. Looking at the contributions to the 18% sell off in the S&P 500 Index for the year, we see that valuations drove over 100% of the decline. The forward price to earnings ratio contracted 20%, while dividends contributed a positive 1.3% and consensus earnings estimates fell slightly (<1%). As shown below, the move higher in interest rates was the driving force behind the decline in valuations, with the two moving in opposition (note inverted axis in graph below).

Source: Bloomberg LP, 1/17/2023, Innovator Research & Investment Strategy

The strong equity rally to start 2023 has been no different. Bond yields have moved lower, resulting in higher valuations, and the S&P 500 Index gained 4% in the first 10 trading days. This begs the question, is the move down in rates sustainable? We don’t think so. While there is a narrow path to justify the recent move, we believe investors should position their portfolios accordingly, where rates may be structurally higher for longer.