Investors are hoping for a stock market recovery in May after a disastrous April, but more bad news might be on the horizon. It’s important for investors to keep an informed view of current market and economic conditions.
Analysis of the current market drivers in historical context provides a clear picture of what’s going on right now — and when it might change in the future. Keep this information in mind as you manage your investment portfolio for long-term growth.
1. Corporate earnings won’t stop the bleeding
The market is right in the thick of earnings season again, with about half of the S&P 500 left to report first-quarter results. Earnings were better than expected and strong overall in the fourth quarter, and those positive surprises helped to offset downward pressure on stocks. Things are less encouraging so far this time around.
Most companies are still exceeding expectations, but there’s a clear slowdown in growth that’s impacting the stock market. The blended average earnings growth rate for the S&P 500 is around 7% so far, which is the slowest rate of expansion in nearly two years. It’s a sign that economic productivity is finally normalizing from the pandemic disruption.
Commentary about outlook for the rest of the year by CEOs isn’t great, either. Earnings guidance has been slightly negative overall, reflecting rising pessimism among corporate leadership. Investors, analysts, and executives all share concerns that the combination of inflation and rising interest rates is likely to hurt consumption and overall business activity. That’s bad news for sales, corporate profits, and stocks.
Those are all valid reasons for concern, but it’s important to recognize that the stock market is taking a beating despite receiving overall positive news from corporate earnings. Growth might be slowing, but it’s still well above historical averages, and it’s smashing the 5% rate of expansion that Wall Street was forecasting one month ago.
Earnings season looks even better if we exclude Amazon, which is dealing with a tough combination of challenges right now. The S&P 500 would be growing more than double digits without the impact of the e-commerce giant. Even the headline-grabbing gloomy outlook is more lukewarm than outright threatening.
The stock market hit valuation levels that were only sustainable with support from spectacular corporate fundamentals. It was never realistic to expect huge growth figures indefinitely. Those sorts of results are no longer available, and 7% corporate earnings growth is being accompanied by a market correction.
The second half of earnings season won’t be a lifeline for the market in May, though individual stocks could get bumps from bullish reports.
2. The bottom won’t come in May
As stocks continue to struggle, investors inch closer to a buyer’s market. Savvy investors will keep this on their radar.
Rising interest rates and concerns about a looming recession are causing investors to pull capital from the market. Stocks are getting cheaper relative to fundamentals as a result. The forward P/E ratio for the S&P 500 is around 18 right now. That’s still above the all-time average, but it’s below the five-year average, and it’s way below the level of one year ago, when the forward P/E was 21.
It’s always tough to see wealth eroded by tumbling stocks, but this is actually welcome news for some people. Plenty of investors have been frustrated by irrational valuations over the past two years, and they’ve struggled to find good places to deploy capital. Despite a fairly dramatic move back to reality, the evidence doesn’t indicate that a turnaround is imminent. Interest rates should continue rising all year, concerns about a potential recession should persist for another quarter at a minimum, and valuations still probably won’t hit unreasonably cheap levels in the next 30 days. These are important considerations for portfolio management.
Timing the market isn’t a good idea. It’s almost impossible to predict exactly where the bottom of a market cycle will hit, and there usually have to be clear global economic growth catalysts to reinstate a bull market. Even after valuations come back to earth, stocks can have a long way down from there. Risk appetite tends to swing like a pendulum, propelling major stock indexes to unsustainable highs and lows, but the upward trend has been a constant across long enough time horizons. Still, it’s important to monitor macroeconomic conditions to optimize long-term returns.
Don’t become an extreme contrarian and load up on volatile growth stocks just because the market is getting cheaper. That’s a good way to incur even bigger losses than everyone else. Stick to your long-term allocation strategy, and make subtle changes to volatility as conditions permit. As valuations fall, growth stocks slowly become less risky.
If the market swings below historical valuation averages, it’s suddenly a great buying opportunity for long-term growth. Just don’t be shocked if it gets worse before it gets better. I expect value stocks to continue outperforming growth stocks in May, but a portfolio readjustment is officially on my radar for future months.
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