Timely and Relevant News: Potential Catalyst for a Market Turnaround
After a tough start for stocks in 2022, investors are looking for reasons to expect a rebound. After more than doubling off the pandemic lows in March 2020, without anything more than a 5% pullback in 2021, stocks probably needed a break. However, that doesn’t make this dip feel much more comfortable.
In our recent 2022 Market Outlook presentation, we shared that it would not be surprising or unreasonable to see a 10-15% correction in the markets. It is important to remember that pullbacks are normal. Stocks have averaged three to four pullbacks each year (5–10% drops) and one 10–20% correction.*
Ward Keever, President and CEO of Covenant Wealth Strategies is often quoted as saying, "the market is an escalator on the way up, and an elevator on the way down." Markets generally move up relatively slowly and can move down rather suddenly from time to time. However, these down drafts often represent “buy the dip” opportunities.
It is important to not lose sight of your long-term goals as volatility occurs and to maintain your perspective in the midst of market ups and downs. We continue to see 2022 being an overall positive year.
Tough start to the year
It’s been a rough few weeks for the stock market. Fears of rising rates and the Federal Reserve pulling back its stimulus more aggressively than previously anticipated to fight high inflation have caused most of the market jitters.
The pain has been particularly acute for the many growth stocks that make up the Nasdaq Composite, which has corrected 14% from its November 2021 high. This is the third worst start to a year for the Nasdaq (down 10% year to date), though it was positive the rest of the month the last five times it was down 5% or more year to date through January 20.
Small caps have been hit even harder, with the Russell 2000 Index nearly in bear market territory with its 18% decline since November 8, 2021—though the higher quality S&P 600 small cap index has fared better in losing 12% during this period.
What might turn the markets around?
Stabilization in interest rates would help. The 10-year Treasury yield’s inability to break through 1.9% last week and subsequent dip below 1.8% is a good start. Stock valuations are interest rate sensitive and become harder to justify as bond yields go higher (the price-to-earnings ratio for the S&P 500 using the 2022 consensus estimate for earnings per share is currently a touch below 20).
Inflation is clearly a key risk factor for markets right now. January 2022 CPI data is scheduled to be released on February 10, 2022. We could soon see more evidence of easing supply chain bottlenecks and more people jumping into the workforce as COVID-19 disruptions fade (there are a near-record 10.5 million open jobs in the U.S. now compared to less than 7 million pre-pandemic in December of 2019). The stock market will gain more confidence once inflation begins to ease. A Fed meeting this week without any negative surprises would also help. Stable or lower oil prices would help as well.
Earnings growth will likely be the primary source of stock market gains this year. The downward pressure on stock valuations from higher interest rates makes that more likely.
In Figure 1 below, we have outlined annual returns for the S&P 500 into earnings growth, valuation changes and dividend yield. During 2019 and 2020, when the S&P 500 returned 24.7% annualized (55.7% cumulative), increases in valuations (aka "price multiples") drove much of the gains. That changed last year when earnings rose an estimated 50% and valuations contracted. We expect 2022 to look more like the mid-cycle mid-2000s or mid-2010s with more modest returns, more contributions from earnings growth and dividends, and little, if any contribution from valuation.
The volatility we’ve seen this year is uncomfortable, however it is well within the range of normal based on history. After just one 5% dip last year and huge gains off the 2020 lows, we were due for a dip. We think suitable investors may want to consider "buy the dip" opportunities.
If you have specific questions related to your own investment strategy or financial planning needs, we welcome you to call us at 302.234.5655 or email us atcontactus@covenantwealthstrategies.com to set up time to discuss further.
Disclosures:
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy. U.S. Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio. Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.
*Data from LPL Research going back to 1950.
All index data from FactSet.