Positive signs amid “wall of worry”
By Kyle Tetting
It’s hard to argue with the year-to-date success of the vast majority of investment categories. As I write this on April 26, broad measures of stocks like the S&P 500 had gained more than 6% with only a few trading days left in April. Similarly, less volatile measures like bonds have added half as much or more.
Positive numbers are a nice change of pace after 2022’s declines, especially when you consider that the most recent rally really began around the start of the fourth quarter of last year. In other words, this run higher isn’t just a function of the changing calendar.
While the gains are encouraging, I am struck by how pessimistic many of the headlines remain. “Markets climb a wall of worry,” the saying goes, and that seems especially true now, though investing from a place of worry is tough.
Consider that, according to data from Refinitiv, S&P 500 companies saw declining earnings between the fourth quarter of 2022 and the same time the year before. The pace of decline is forecast to increase in the first two quarters of this year, and amid ongoing reporting on first-quarter earnings, it now seems likely we’ll see declines of as much as 4.7% compared to the first quarter of 2022.
The will-we-or-won’t-we debate over economic recession rages on, but for all intents and purposes, the earnings recession is here. Hurt by rising costs, ongoing supply chain disruptions and continued economic uncertainty, corporate America is already showing signs of slowdown with earnings reports carrying on in earnest through early May.
The good news is most expectations are for a return to earnings growth later in the year, with an especially large jump in the fourth quarter pushing the S&P 500 back into record profits for the full year.
The timing of that return to profitability may be tough to nail down, but move it forward or back a quarter and the story doesn’t change much.
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The current economic pains have resulted in some near-term stagnation, but American corporations continue to show resilience. Many industries like tech, for example, have shown a renewed focus on profitability by emphasizing efficiency improvements.
Cost-cutting and rightsizing can help boost future profits, but they also weigh on a company’s ability to operate. As a result, the impact is never immediate. Add in some emerging opportunities for businesses, and the outlook for investors begins to look rosy beyond the immediate uncertainty.
Unfortunately, the near-term uncertainty also accompanies some higher valuations on stocks. But here, too, the hard data may not tell the complete story.
On a forward-looking basis, the S&P 500 trades at more than 18 times earnings over the next 12 months. That is a bit higher than even elevated near-term averages, though not so high that valuations alone should cause concern. In other words, a forward price-to-earnings ratio of 18 is well within the normal range of measures.
Further, measures of forward earnings currently include the tail end of the previously mentioned earnings recession. If future expectations are even moderately close —pushing a quarter back or missing by any normal amount, a return to earnings growth will lower the P/E ratio simply by raising the denominator in the equation, the “E” for earnings.
With earnings forecast at more than $246 per share in 2024, the S&P 500 trades at about 16.5 times 2024 earnings. We can’t cherry pick the data and there is work left to be done to realize those expectations, but simply trading sideways for a couple of quarters quickly shifts the conversation on valuations back in investors’ favor.
All of this all sets up nicely for a return to a more normal environment for stock returns in the years to come, but it tells us nothing of the current condition. The ongoing conversation on the debt ceiling, continued pressure on banks, inflation, war and many more issues continue to weigh on the day-to-day.
So, while I can remain optimistic about a return toward more typical stock returns, we must navigate the uncertainty with appropriate caution. A diverse approach is more necessary than ever, in part because we finally see the benefit of higher rates, but also because stocks alone can’t provide for all our needs. Instead, we must continue to understand the role that our investments play, hold cash where appropriate and allow ourselves time to roll with the inevitable punches.
Kyle Tetting is president of Landaas & Company.
2023 outlooks not bound by the calendar by Kyle Tetting
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Stocks: Long-term, consistent returns, a Money Talk Video with Dave Sandstrom
Making financial sense of “breaking news,” a Money Talk Video with Art Rothschild
(initially posted April 27, 2023)
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