What past S&P 500 drawdowns reveal about today’s market, according to RBC

RBC Capital's analysis of significant S&P 500 declines over the past six decades suggests that today's market may be more resilient than it appears. Lead U.S. equity strategist Lori Calvasina examined every S&P 500 drop of 11% or more from a record high since 1956, identifying common triggers such as looming recessions, rising interest rates, stretched valuations, geopolitical shocks, volatile oil prices, and major conflicts.

Key trends during these severe market stress periods included falling corporate profit growth, downward revisions to earnings forecasts, declining valuations, sharp sentiment drops, and widespread layoffs. Economic growth and manufacturing activity also weakened during these periods.

Today, however, the picture is markedly different. RBC notes that corporate profitability has improved, and earnings forecasts remain upwardly revised. While consumer confidence has suffered and investor sentiment is far below its peak levels, manufacturing and industrial production are gradually recovering. These indicators could falter as the Federal Reserve initiates rate hikes and bond yields climb, potentially triggering a deeper market decline than the 5% to 10% RBC anticipates.

Nevertheless, the stock market currently appears optimistic, adopting a "innocent until proven guilty" stance.

Notably, the 10-year Treasury yield has surpassed 5% and has moved in tandem with oil prices since the Iran conflict commenced. RBC maintains its 12-month S&P 500 target at 8,150, but a new stress test accounting for 3% inflation, four Federal Reserve rate hikes, and a 5.25% 10-year yield suggests a fair value of just over 7,900.