The bear market has been driven by multiple compression, making valuations look relatively compelling. Yet, expected weakness in earnings may limit the upside potential for stocks, economists at Charles Schwab report.

Fed remains engaged in one of the most aggressive rate-hiking cycles in history

“The indisputable reality today is that the Fed remains engaged in one of the most aggressive rate-hiking cycles in history. Confirmed by what we've seen this year, that has historically weighed on valuations.” 

“Growth-heavy stocks represent a much larger portion of the market today compared to the last era with inflation running above 8%. If higher interest rates continue to dent those stocks' value, and earnings growth slows, there is less upside for profit margins.”

“It isn't precision around the magnitude of the decline in multiples that matters. Rather, it's the direction; and as of now, that continues to point downward…consistent with the downward trajectory of earnings growth estimates.” 

“At the mid-June lows, stocks were discounting a lot of negative news. Recent weakness clearly reflects still-hot inflation and a ‘don't fight the Fed’ mentality. But still largely ahead is a further rerating of earnings estimates and likely continued volatility in stocks. Stay disciplined.”