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By Adam Day, Financial Advisor
6/12/24
LOOK BACK: Why is the market where it is, and is it justified?
Highlights:
The market feels hotter than it is because companies are putting down lower targets so they can outperform. And, the largest companies don't have to deal with higher interest rates so higher valuations can be justified.
There is a potential that we stay around this same level of inflation for a longer period than we would hope for.
The market seems disconnected from consumer sentiment coupled with savings built up over time being spent down.
There are points for optimism.
As we roll into summer, the market volatility that kicked off the second quarter is seemingly well into the rearview mirror. We have once again reached all-time highs for the S&P 500, my preferred index of the US stock market. While the year-to-date advances have been great, it's even better when we think back to just 18 months ago as we closed out 2022. The S&P 500 is over 1500 points higher since then…
Why doesn't the market feel right with sentiment? While stock market advances are great to see, they don’t always feel great as they happen.
I recall many conversations throughout the 2010s following the financial crisis, where many investors felt that the stock market was not indicative of how the world outside of Wall Street seemed and that at any moment we would retreat and - then some - back to the March 2009 lows. However, even with strong sentiment among consumers and investors, the market didn’t care. The 2010s were mostly a march upward with few interruptions.
I’m hearing a lot of similar rhetoric at the moment, both in serious client conversations and by talking heads on my phone screen or as I like to refer to it, my 3 x 6” brick of anxiety (kidding). I understand where people are coming from now, better for multiple reasons including having children with college savings to consider.
These are more subjective than objective lenses to look through for client conversations and concerns, so let’s take a moment to look more into the objective pieces to show why the market is where it is, and if it’s justified.
1. Sandbagging.
We’ve seen this trend a lot over the past few years and it seems to work for companies. The playbook is simple. Issue soft forward guidance and beat said guidance. Q1 earnings season wrapped up with a few key metrics, according to Factset:
79% of S&P 500 companies have reported a positive earnings per share surprise and 61% of S&P 500 companies have reported a positive revenue surprise. With tech, healthcare, consumer staples and industrials sectors leading the index.
For Q1 2024, the blended (year-over-year) earnings growth for the S&P 500 was 5.9% as of 6/12/24. If 5.9% was the actual growth rate for the quarter, it would mark the highest year-over-year earnings growth rate reported by the index since Q1 2022 (9.4%).
2. Valuation.
From our friends at Factset: "The forward 12-month price to earnings (P/E) ratio for the S&P 500 is 20.7. This P/E ratio is above the 5-year average of 19.2 and above the 10-year average of 17.8. However, it is below the forward 12-month P/E ratio of 21.0 recorded at the end of the first quarter (March 31)."
In summary, the market is cheaper than it was a few months ago, and slightly more expensive than it was this time in 2019. A lot of money has been made in the stock market since then.
A note on the spread between the 10-year average P/E and the current P/E. Over the last decade, the big companies have only gotten bigger, but justifiably so.
The largest names in the S&P 500 have the ability to control pricing power
They control margins and have demonstrated their ability to grow earnings consistently. Not only that, most of these companies have so much cash, that higher interest rates for borrowing money isn’t an issue if they don’t need to borrow.
If all of that wasn’t enough, they have a steady flow of stock buyers with the amount of money that automatically is heading to their stocks with retirement savings in investors' 401(k)s, 403(b)s, pensions etc. With the popularity of indexing in these retirement plans - by design, investors are buying companies with the most market cap.
Therefore the biggest names are receiving the most flows.
Why doesn’t it feel right?
3. Inflation is sticky.
While the rate of inflation has come down significantly, since the end of 2022, it's still present.
A big factor, in my opinion, is the scar tissue of how painful it felt during the now, four-year battle of inflation starting, rising, and now being in the disinflation period.
Separate the news from the noise.
Inflation going down (disinflation), does not mean prices are going down. It means that prices are going up less rapidly than before.
The media loves to mix and match terms to fit the narrative.
While the rate of inflation has gone down, we are into the stickier parts of the fight, which is services inflation. The main driver of the cost of services is wages for employees. Most of whom get cost of living pay raises at year-end.
So there is a potential that we stay around this same level of inflation for a longer period, than we would hope for.
4. Consumer sentiment.
While much better than two years ago, consumer sentiment is well below its 50+ year average. Investors are not feeling confident that their dollar will stretch as far in retirement and some of that sentiment is notated in the Wall Street Journal. When surveyed, people said the “magic number” for retirement has increased, up about 15% from last year.
CHART OF THE DAY: Additional drivers to how the economy feels like personal savings rate going down, household excessive savings going down combined with checking/savings going down for the 60-80% income percentile.
YOUR GAME-CHANGING QUESTION ANSWERED: "HOW DO I DEAL WITH ALL THIS UNCERTAINTY?"
Some points of optimism.
If you have a home, and an investment portfolio, you are likely as wealthy as you have ever been. Be thankful for that and use this time to reassess how much risk you are willing to take. Now that rates are higher, there are options for capital appreciation outside of just owning stocks, which was not the case for most of the last 15 years.
Federal Reserve policy is set to ease.
The market entered 2024 with extreme optimism of six rate cuts, none of which have happened yet. Now it's looking closer to two cuts, possibly. Despite the lack of cuts, companies have still grown earnings. So when those cuts do happen, earnings have the possibility to broaden across the market, as the cost of borrowing decreases.
The market is a forward-looking instrument.
The market is more interested in what is to come than what currently is, which is why when it falls, it's generally a quick fall down, with a slow advance back upward.
All-time highs generally lead to all-time highs.
It might seem counterintuitive to buy something when it’s the highest price, but the data indicates otherwise. Certainly, money can be lost in the short term but as the timeframe extends, the likelihood of positive return increases. The chart below, shows the difference in buying into the S&P 500 on an all-time high day, versus any other day.
As you can see, one year removed from the investment, there is about a 0.6% difference positively for buying at all-time highs vs. any other market day.
Stay Informed, but don't obsess.
While it's important to stay informed about financial matters, obsessing over market fluctuations or economic news can increase anxiety. Stay informed, but also recognize the importance of maintaining a healthy perspective.
Markets hitting all-time highs is what we want as investors and is a very normal occurrence that happens an average of 17 times per year.
Two of the best things you can do as an investor are celebrating the advances and to reevaluate how much risk you want to take.
THE LATEST: Ascend Advisory named to 2024 Forbes Best-in-State Wealth Management Teams (read the PR release).
2024 Forbes Best-in-State Wealth Management Teams: Awarded January 2024; Data compiled by SHOOK Research LLC based on the time period from 3/31/22 - 3/31/23 (Source: Forbes.com). Fee paid for use of marketing materials.
The Forbes Best-in-State Wealth Management Teams rating algorithm is based on the previous year’s industry experience, interviews, compliance records, assets under management, revenue and other criteria by SHOOK Research, LLC. Investment performance is not a criterion. Self-completed survey was used for rating. This rating is not related to the quality of the investment advice and based solely on the disclosed criteria. Fee paid for use of logo.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.
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