The S&P 500 could fall below the 5000 mark if macroeconomic pressures, especially high inflation, persist, according to RBC Capital Markets analysts in a note released on Monday.

The report emphasizes that the market’s current price-to-earnings (P/E) ratio might decline under ongoing inflationary pressures and a lack of anticipated interest rate cuts by the Federal Reserve.

RBC’s base model, which uses consensus forecasts on economic variables, suggests that the S&P 500 should trade at around 21.5x earnings by the end of 2024. This projection could place the index at 5100 to 5300, assuming their earnings per share (EPS) forecast of $237 for 2024 is accurate.

However, in a stress test scenario where there are no Fed rate cuts, higher-than-expected inflation, and 10-year Treasury yields do not rise above 5%, the P/E ratio could drop to 20.8x, potentially pushing the S&P 500 down to a range of 4900-5100.

In another stress test, considering inflation exceeds 3% and the 10-year yield rises to 5.5%, the trailing P/E could fall to 19.1x. This scenario suggests a fair value of about 4500 for the S&P 500 based on RBC’s EPS forecast and a range of 4600-4700 using consensus EPS.

RBC also reviewed the latest performance of small caps compared to large caps.

The investment bank notes that small caps, as measured by the Russell 2000, have been retesting their relative lows compared to the S&P 500. Despite a brief rally driven by optimism over Fed rate cuts in early May, small caps have struggled, with only 62% of Russell 2000 companies beating consensus estimates in the recent reporting season, compared to 77% for the S&P 500.

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