Basically, the start of 2022 has been difficult from the start. Both Equity and Bond prices have fallen, while inflation and interest rates have risen. The news on TV and social media is mainly negative and many of our clients wonder what will cause equity markets to move more positively in the hopefully near future? Here are some possibilities for better equity markets down the road:
BULL CASE #1: INFLATION PRESSURES WILL LIKELY EASE
The amount of time it takes for stocks to return to prior highs will be determined by the path of inflation. LPL Research expects perhaps 1.5 percentage points to come off core consumer prices by year-end—the latest reading for the Fed’s preferred inflation measure, the Core Personal Consumption Expenditures (PCE) Index, excluding food and energy, was 4.9%.
It’s fair to say a lot has to go right for that to happen, including easing supply chain disruptions, more workers entering the labor force, and a cease-fire in Ukraine. But LPL’s view is progress on these fronts over the next seven months is more likely than not. Historically, lower inflation tends to bring higher valuations.
BULL CASE #2: CORPORATE AMERICA ENJOYING SOLID EARNINGS MOMENTUM
We just got through first quarter earnings season and while it wasn’t pretty, the S&P 500 earnings growth rate (9.3%), the percentage of companies beating earnings estimates (78%), and the change in the consensus next 12 months estimate for the S&P 500 during reporting season (+0.5%) were all excellent. Revenue growth exceeded 13% on a year-over-year basis, as companies were able to generally pass through price increases, limiting pressure on profit margins.
There were some high profile misses, particularly among retailers, and energy certainly helped prop up the numbers (about 6 points of impact on overall S&P 500 earnings), but given the challenges of cost pressures, labor and materials shortages, and supply chain disruptions, companies did an excellent job managing through a challenging environment.
BULL CASE #3: VALUATIONS ARE TOO LOW
Lower inflation supports higher equity valuations. The same can be said for interest rates, as lower rates increase the value of future profits and make stocks more attractive relative to bonds. So, if inflation comes down in the coming months as LPL expects, interest rates are likely to stay in this range (LPL’s year-end forecast for the 10-year U.S. Treasury yield is 2.25—2.5%).
LPL also believes that stocks, at recent lows, were pricing in perhaps as much as a 50% chance of recession over the next year based on the magnitude of the stock market’s decline. LPL sees the odds of a recession in the United States during this time frame as lower than that (perhaps one in three, if not lower). LPL expects valuations to recapture some of the lost ground by yearend as markets come around to LPL’s view that this is a growth scare and recession is not imminent. The process to get there may not be smooth for markets, especially over the next month or so, but LPL thinks it happens over the balance of the year.
So here is some good news presented by LPL’s Research team that helps us “stay the course” on our equity investments. If you have any questions, do not hesitate to contact us. – Mark and Elise
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary dated 5/31/2022, tracking #1-05287672. LPL Approved Tracking #1-05288475.