Turning Point

What a difference a new year can make – January kicked things off with a bang!  After suffering through one of the worst years on record for both stock and bond prices in 2022, stocks surged upward in January by 6.3%, as measured by the S&P 500.  This rebound in prices may be simply a reversion to the mean or they could be a signal from the Federal Reserve that its monetary policy has in fact begun to reverse. The difference is critical in understanding what comes next.

The market has rebounded to the extent that some observers believe the long downward trend (bear market) may finally be broken.  From a technical perspective, optimists see a constructive trading pattern for the S&P 500, moving through its 50- and 200-day moving averages with a series of higher lows and higher highs.  Among the stocks that have performed especially well this year are many that were the worst performers last year, as well as smaller cap stocks and stocks with a high level of revenue generated overseas.  Of course, we don’t know yet whether the tide has turned, but there are green shoots emerging.

More than ever before, we are inundated with an array of economic reports measuring all aspects of the economy.  From these reports, there looks to be a consensus that US economic activity is slowing.  Based on their most recent meeting, where they raised the Fed Funds rate to 4.50-4.75%, the Federal Reserve says it is looking for inflation to come down and has not yet seen improvement in disinflation from core services.  However, it is reasonably clear that both wage growth and inflation are beginning to ease off; news that is music to the ears of stock investors.

The behavior of the consumer is pivotal and consumer confidence is on the rise as consumer spending represents roughly 68% of GDP.  Typically, after consumer sentiment troughs, which it did in late 2022, the S&P 500 generates positive returns in the subsequent 12-month period (JP Morgan Guide).  This may be an optimistic take on the data, or again, a reversion to the mean.  The fact remains, the job market is robust and people are employed.  The bet here is the US consumer continues to consume.

As fundamental analysts and stock pickers, we are quite focused on corporate earnings.  So far, as many had thought, earnings reports for 4Q22 have been challenged.  There are references to margins tightening due to too high inventory levels and the unwinding of the over-hiring that took place amidst COVID.  According to FactSet Research, the number of companies that are beating their earnings estimates is low, as are the revenue reports.  Yet the forward guidance remains reasonable with forward estimates reassuringly at $225 for 2023 and $250 for 2024.

Many of the obvious market risks look manageable.  On the valuation front, stocks are trading at 17.9x forward earnings, a slight premium to the 25-year average (JP Morgan Guide to the Markets).  The worrisome effect of geopolitical tensions and war in Ukraine are not (at the moment) apparent in the energy markets.  Inflation data is retreating rapidly and the US dollar has come back into a more balanced range.  Unknown risks of course remain.  These “fat tails” can take the markets by surprise and create immense volatility. 

My hope is that we continue to see positive signs on the economic front and continued resilience in corporate earnings.  I think the market’s optimism is infectious, and historically prices rise approximately 70% of the time.  Our view remains tilted toward owning attractive growth stocks with dividends – we continue to invest with long-term returns in mind.  At the same time, I can easily see a more saw-toothed pattern for stock prices in the coming months, as there remains  a great deal of concern as to whether we can manage a soft landing. 

It’s that time of year again, so keep an eye out for your 1099’s.  Please let us know if you would like to schedule a review.  We are happy to invite you to our office in Wayne or we can of course call or Zoom.  Take good care.

Bruce Hotaling, CFA

Managing Partner