Let’s Leave It There
Stock prices measured by the S&P 500 received a “leg up” in October, rising 8%. Interestingly, the tech-laden Nasdaq was up 3.9% while the more traditional Dow Jones Industrials rose a more impressive 13.9%. The move in the S&P was strong, echoing the 9.1% move in July, and leaving prices now down 17.7% year to date.
As are many, we are waiting for the Federal Reserve to complete its rate-hiking campaign. This is the principal overhang on the markets and has been since the beginning of the year. As I’ve said before, the drop in stock prices this year is entirely due to the rising rate backdrop and the subsequent downward pressure on the market multiple (P/E ratio). According to JP Morgan the P/E ratio at the start of the year was 21.4x and is now 16.7x. Valuations are in a reasonable range, hovering around their 25-year average.
We are seeing some change in the forward expectations for earnings growth. Estimates have decreased since the end of 3Q 22 – not by a lot, but the question looms: how much will they slow? According to FactSet Research, earnings growth for the 3Q 22 was 2.2%, the lowest rate since the -5.7% reported for 3Q 20. Analysts are forecasting a more modest 0.5% growth in earnings for Q4 and 6.4% for the full year 23. Looking out, 2023 EPS estimates have been revised down -2.4% since the beginning of earnings season to $233.79 per share (and $255 per share for 2024).
Inflation is the problem and the Fed’s tightening cycle will squash it, at some point. Recent economic data has shown changes in the labor market but we are also seeing layoffs and hiring freezes, which suggest the Fed may be closer to a pause. In earnings calls, the backdrop is uncertain. Some noted concerns are foreign exchange (the strong dollar), zero-COVID in China, the war and its impact on Europe, inflation, and a still recovering supply chain. Margin pressures are also cited resulting from the above, relating to mismanagement and backups of inventory backups.
Nearing year-end, I expect the market to remain noisy due to the effects of tax-loss harvesting; there are a lot of popular stocks with unrealized losses this year. And a more optimistic consideration are the historical trends around the upcoming midterm elections. According to Bespoke Investment Group, year two of the election cycle (this year) has seen the S&P up only 56% of the time, while year three (next year) has produced a rise in prices 82% of the time.
Looking forward, I would like to see a few things begin to take shape in order for the markets to stabilize. In alignment with Vermilion Research, I agree that commodity prices, the US dollar and the 10-Year Treasury all need to begin heading down. As previously mentioned, inflation must tip down and the Federal Reserve has to finish its rate tightening exercise. Finally, forward earnings need to hold up.
Patience is the key. We are seeing great swings in investor interest between value and growth stocks, and in general, valuations continue to favor value stocks. This leads us more into the “growth-at-a-reasonable-price” camp. Along with valuation, dividends and quality characteristics remain important factors for us in selecting stocks. The market tends to go through periods where the leadership changes, and a new group of “top dogs” emerge. Therefore, we are watching closely for signs of cracks in the dominance of some of the mega cap tech names that have been so prominent in the last 10 years. History shows they will not remain on top forever.
While we wait for the storm to pass, we are having a party to celebrate the 10th Anniversary of our office here in Wayne, PA (though we have, in fact, been in business through different forms for nearly 30 years). We have some wonderful artwork from our friend Kirby Fredendall (www.kirbyfredendall.com) in Bucks County on display in our newly renovated offices. The date of our celebration is Thursday December 1st and we would love to see you there.
We have been reaching out to many of you for year-end wrap-ups and to address any planning for the coming year. If we have not been in touch and you would like to schedule a call or meeting, please let us know.
Take good care,
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are as of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.