Investing.com -- The recent decline in the S&P 500 is being misinterpreted by many investors, according to Sevens Research.
While economic growth is undoubtedly slowing, this isn't the primary issue for markets, the firm said in its latest note.
Instead, they believe the real problem lies in valuation, with stocks trading at levels that reflect an overly optimistic outlook.
Sevens Research highlights that while economic data has been disappointing, such as Friday's weak jobs report, the fundamentals still point to a soft landing rather than a recession.
They note that "claims remain low (in any other era, 228k claims would be considered fantastic!)" and that key growth metrics like the ISM Services PMI, retail sales, and durable goods have plateaued but aren't declining.
For Sevens Research, the issue is that the market's pricing doesn't match the economic reality.
"At these levels the S&P 500 is trading at 20X next year’s earnings," writes Sevens. "That’s not a soft landing multiple (it’s more like 18-19 if we’re being generous). A 20X multiple is a 'no landing' multiple and I get the impression investors are rooting for a soft landing, but their definition of a soft landing is basically stable growth. I’m afraid it doesn’t work that way."
Given the inflated valuations, Sevens Research warns that the S&P 500 could decline "200-400 points from here" before it accurately reflects the economic risks.
"If economic data stays about where it is now, the S&P 500 will be more appropriately priced and at that point, risks will skew to the upside," said Sevens.
They advocate for a more cautious approach, recommending defensive sectors over tech and growth stocks. "That’s been working since the August drop and I think it’ll continue to work in until growth troughs or the market declines to better reflect actual fundamentals," the firm concludes.