Stocks rebound notwithstanding all the bad news

Markets summary 

Since the equity market bottomed on 8th March, European and US markets have rebounded strongly, advancing by 10% and 9%, respectively.  At last Friday’s closing level, the S&P 500 in the US is less than 6% shy of its record high established at the turn of the new year.  This is remarkable at a time when there seems to be bad news on pretty much every front.

Geographically, Russia invaded Ukraine, and the brave resistance of the Ukrainian people makes it look like this conflict will not be over any time soon.  This has the capacity to either spiral into a major global conflict, or to drag on for years.  Either one of those outcomes would first and foremost be a human tragedy, but it would also drain money out of the global financial system and slow growth massively.  This is bad enough news for stocks, but when you factor in the wild card of China’s reaction, it could get even worse.

Then there is monetary policy.  For years, the biggest supporting factor for stocks has been loose monetary policy.  Ultra-low interest rates and a market washed with liquidity meant that stocks were attractive relative to bonds, and that banks had plenty of cash to lend out and support the rise in equities.  Those conditions are now changing, with the Federal Reserve in the US embarking on a period of rate hikes and talking about how they intend to catch up for their tardiness in responding to inflation by being tough now.

The reason for such a turnaround in the markets may be attributed simply to corporate profits.  When an investor buys a stock, he/she is buying a slice of the prospects and profits of a company.  All of the problems outlined above affect future prospects, things that may happen in the future, but that doesn’t mean we can ignore what has actually happened in the recent past, and that is massive increases in corporate profits.

We have just finished an earnings season that gave us a fourth straight quarter of 30%+ earnings growth.  That is in part due to the fact that earnings were still being negatively impacted by covid a year ago, but by then, the impact was not that large.  Corporations globally faced some massive challenges and have adapted and thrived.  Many CEOs were cautious about the rest of the year, which is understandable, but that caution is fully priced in.  Forward Price to Earnings ratios, which compare prices to projected earnings over the next twelve months, have also fallen as analysts have cut estimates, and the average for the S&P 500 is now close to 18.2, down from 18.7 of the last quarter and 20.1 one year ago.

Most importantly from an equity pricing perspective, is that this has happened as stock prices were falling, resulting in a big change in P/E multiples.  If prices are falling and earnings are rising at the same time, P/Es will drop significantly, and that is what we have seen.  A year ago, the trailing P/E of the S&P 500 was 44.7, whereas of Friday’s close, it stood at 24.8.  This is still a bit above the long-term average but given that growth has been accelerating so much over the last decade or so due to automation and other efficiency improvements, it looks quite reasonable.  One might even say it looks cheap.

There are risks, for sure, and if they play out in a bad way, stocks will fall further later this year.  The market, however, will deal with those problems when and if they come.  For now, at least, the big corporations are once again showing that they are strong, innovative, and adaptable, and that they can make money no matter what.  As long as that is the case, even a news cycle dominated by doom and gloom cannot dent stocks too much, and every selloff will prompt buying.


Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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