Stock Price Pressure and Volatility Likely in the Near-Term, but Focus on Long-Term
May 19, 2022
Stock prices continue to be under significant selling pressure and volatility remains high as investors contemplate the impact of Fed policy and inflation on both economic growth and corporate earnings. The S&P 500 Index has declined 18.2% 1 from the recent and all-time high reached on January 3, 2022, placing the Index close to bear market territory2. Growth stocks, as measured by either the NASDAQ Composite or the S&P 500 Growth Index, are already experiencing a bear market, down 28.9% and 27.0%3, respectively, from their most recent highs. While gut-wrenching, it is probably important to keep in mind that despite this decline, the S&P 500 is still up 15.9%4 from the pre-pandemic high twenty-seven months ago. Not that bad considering this time frame included the total shutdown of the global economy.
Unfortunately, heightened stock market volatility and price declines may persist in the near-term. The U.S. Fed remains steadfast in its fight against inflation and has only just begun raising the federal funds rate and reducing the size of its balance sheet, both of which will likely lead to a slowing of economic and corporate earnings growth as we proceed through 2022 and into 2023. And inflation, currently at the highest rate in forty years5, is starting to negatively impact both corporate profitability and consumer spending patterns. During the recent first quarter corporate earnings reporting season, 85% of S&P 500 companies cited inflation during their earnings calls with analysts6. This even included mega companies Amazon and Wal-Mart that noted specific negative impacts to costs and profitability resulting from inflation pressures.
The decline in stock prices has resulted in a considerably more reasonable stock market valuation level than earlier in the year, but valuation remains susceptible to further compression. The S&P 500’s price/earnings valuation of 17.8x, based on our 2022 estimate, is down from 21.8x at the January peak7; however, high inflationary environments tend to coincide with more modest price/earnings ratios. In addition, an increase in investor pessimism may also weigh on valuation. The average price/earnings ratio for the S&P 500 over the past 40 years is roughly 16x, and while not a forecast, a move towards such a level is certainly within reason.
While the economy and stock market face several near-term challenges, it is important to acknowledge that not all is bad. The labor market remains remarkably strong with both a near record low unemployment rate (3.6%) and a record number of job openings (11.5 million, almost 2x the number of unemployed)8, personal income is rising (up 1.3% in the first quarter of 2022 versus the prior quarter, which is an acceleration over the last two quarters of 2021)9, and consumer demand remains solid (personal consumption expenditures excluding food and energy in the first quarter of 2022 increased 2.3% versus the prior quarter, which is an acceleration from the last two quarters of 2021)10. Furthermore, many economists believe inflation has peaked; and if such is the case, then the Fed may not need to be as aggressive with rate increases as expected, increasing the odds of a successful economic ‘soft-landing’11. Such a scenario could certainly improve investor sentiment.
While current stock market conditions are hard to ignore, it is always important to keep focus on long-term investment objectives; and most long-term investment objectives can only be reached with an asset allocation that includes some amount of exposure to equities, which historically and over the long-term have proven to be an important source of investment return. At all times, but especially during periods of financial market stress like the current, we encourage you to reach out to your investment team should you have any concerns regarding the financial markets, economy, or your portfolio. An assessment of your portfolio’s asset allocation in relation to your investment objectives and planning for near-term liquidity needs are always a beneficial exercise.
1. Price change (ex. dividends) based on May 18, 2022 closing price – Factset.
2. Bear markets are generally defined as a market decline of more than 20%.
3. Price change (ex. Dividends) based on May 18, 2022 closing prices – FactSet.
4. S&P 500 price return from February 19, 2020 through May 18, 2022
5. April 2022 one-year percentage change in the U.S. Consumer Price Index (CPI) of 8.2%
6. FactSet Earnings Insight, May 13, 2022
7. Based on the midpoint of WTWM’s 2022 S&P 500 earnings estimate of $215-$225. For comparison purposes, the FactSet consensus estimate is $229.
8. As of April 2022 - FactSet
9. As of March 2022 - FactSet
10. As of March 2022 - FactSet
11. Soft-landing refers to a cyclical slowdown in economic growth that avoids recession. Soft Landing Definition (investopedia.com)
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This material is presented for informational purposes, and nothing herein constitutes legal, accounting, or tax advice. Please consult with an attorney or tax professional regarding your specific financial, legal or tax situation.
The views expressed here are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. Investment recommendations and opinions expressed in these reports may change without prior notice. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.