There is no doubt that equities are much cheaper than they were at the start of the year, after a 23% drop in the S&P 500 since the start of the year confirmed a bear market for the index at the start of the year. week.
However, it is less certain that they are cheap enough. Market volatility and a rapidly changing macroeconomic landscape have muddied the metrics investors typically use to value stocks, such as corporate earnings and Treasury yields, keeping some potential buyers on the sidelines.
“Until we get better visibility on the rate outlook and better visibility on the earnings outlook, the fair value of stocks is a bit elusive,” said Sameer Samana, senior global market strategist at Wells Fargo Investment. Institute. The institute has recently begun advising clients to reduce equity risk and shift funds into fixed income securities.
Stocks came under more pressure this week, with the S&P 500 falling to its lowest level since late 2020, on the heels of the Fed enacting its biggest rate hike in nearly three decades.
This year’s decline has lowered the index’s forward price-to-earnings ratio, which compares its price with its expected earnings, to 17.3, from 21.7 at the start of 2022 – closer to the historical market average of 15.5, according to Refinitiv Datastream.
But while S&P 500 earnings are expected to rise nearly 10% in 2022, according to Refinitiv IBES, some market participants doubt those estimates hold up in the face of runaway inflation and tightening financial conditions.
Wells Fargo Institute strategists forecast positive but slowing earnings growth this year and a contraction in 2023, as they expect a recession in late 2022 and early 2023.
“We advise investors to consider a potentially more challenging economy and earnings backdrop…don’t be fooled by today’s forecast-based valuations,” he said. Chad Morganlander, portfolio manager at Washington Crossing Advisors, who advises clients to continue underweight stocks.
Chart: S&P 500 Timeline –
Morgan Stanley analysts expect earnings to be 3-5% below consensus forecast, leading them to forecast that the S&P 500 is likely to see a “more reliable level of support” at 3,400, or around 8 % below Friday’s level, they wrote earlier this week.
US Treasury yields also play an important role in standard valuation models. Since US debt is considered a relatively risk-free investment, rising yields tend to dampen the attractiveness of equities because it weakens the value of future cash flows in standard models.
Yet shifting expectations about how aggressively the Fed will need to fight inflation have made yields exceptionally volatile in recent weeks, making this calculation more difficult for investors.
The benchmark 10-year Treasury yield has moved in a range of almost 35 basis points this week alone, while the ICE BoFAML MOVE index, which measures the volatility of the Treasury market, is at its highest level since March 2020.
Overall, “the risk-free rate rising the way it has is a headwind for equity indices as well as individual stocks,” Morganlander said.
Some investors think stocks have fallen low enough to start plunging.
Peter Essele, head of portfolio management for Commonwealth Financial Network, advises clients to start buying stocks gradually, anticipating that an oversupply of home furnishings and other consumer goods as well as changing consumer preferences demand will eventually moderate prices.
“I just think equities are wrong when it comes to inflation,” Essele said.
Fed Chairman Jerome Powell, who this week called inflation “far too high”, will give an updated view on the environment when he testifies next week before a US Senate committee.
Others remain hesitant.
Robert Pavlik, senior portfolio manager at Dakota Wealth, thinks a solution to inflation may not be imminent. He has lower than normal equity exposure in the portfolios he manages and favors defensive and inflation-linked stocks such as energy.
“I want to be convinced that inflation is showing signs of slowing down,” Pavlik said. “In the meantime, I’m waiting on the sidelines with extra cash.”