This rule with a perfect record says the market hasn’t bottomed, says Bank of America’s star analyst

Subramanian,  head of U.S. equity and quantitative strategy, says that only 30% of the conditions required for a market bottom are currently triggered following this latest rebound that has taken the S&P 500 SPX, -0.08% up 16.6% from its mid-June low. Usually, at least 80% of the conditions must be registered before the all-clear can be called.

One of these signposts in particular is essential — the Rule of 20. That is when the sum of yearly consumer price inflation and the market’s trailing price-to-earnings ratio is lower than 20 when the market hits its trough.

Currently the market P/E is 20 and CPI is 8.5%, Surbramanian notes. That’s 28.5.

“Outside of inflation falling to 0%, or the S&P 500 falling to 2500, an earnings surprise of 50% would be required to satisfy the Rule of 20, while consensus is forecasting an aggressive and we think unachievable 8% growth rate in 2023 already,” she says.

Meanwhile, BofA also reckons stocks are not sufficiently cheap because the market is underestimating the chances of a contracting economy.

“A 20% likelihood of a recession is now priced in versus 36% in June. In March, stocks priced in a 75% probability of recession. Even on Enterprise Value to Sales, where sales should be elevated by the tailwind of 9% CPI, the market multiple is excessively elevated (+40%) relative to history — possibly because real sales growth ex-Energy is essentially flat.”

Other signposts that must be triggered to confirm a bottom, but currently are not, include: the Fed cutting rates; a 50 basis point or more decline in the 2-year Treasury yield TMUBMUSD02Y, 3.224% ; a rising unemployment rate versus the 12-month low; a sell-side indicator buy signal.

Signals that are currently giving the green light to bulls include: Improving PMIs; and more bears than bulls.

Given all this, Subramanian favors the energy and industrial sectors and suggests selling consumer-focused stocks.

“Industrials could be lifted by already strong capex (it grew +19% YoY in 2Q) and with companies guiding still higher on capex during second-quarter earnings season. Capex may be more of a necessity amid a tight labor market warranting automation and de-globalization, and should hold up better than in prior recessions,” she writes.

The S&P 500 has dropped 10% this year. The Dow Jones Industrial Average DJIA, -0.16% has declined by 6%, while the Nasdaq Composite COMP, -0.13% has lost 17%.