Except for a brief correction earlier this month, it’s been full steam ahead for the stock market over the past six months.
The S&P 500 index (SPY) has jumped 24% during that period.
At the beginning of the year, investor expectations of six or more Federal Reserve interest-rate cuts pushed equities higher. Then, it became clear the Fed wasn’t going to move with anything close to that speed or intensity.
Many experts now predict rates will remain unchanged through year-end. And Harvard economist Larry Summers, former Treasury Secretary, sees a 15% to 25% chance that the Fed’s next move will be a rate increase.
Related: Ex-Treasury official unveils startling interest rate outlook
So now stock bulls are focused on earnings. The idea is that strong economic growth will boost profits.
GDP expanded only an annualized 1.6% in the first quarter, but experts pointed to strong underlying data. Consumer spending climbed 2.5%, and business investment gained 3.2%.
The S&P 500’s valuation is stretched, leading some to worry that it has become overvalued.
TheStreet
Here’s the scoop on earnings
Profits are indeed on the rise. As of April 26, 46% of S&P 500 companies had reported first-quarter earnings.
Combining those numbers with analysts’ earnings estimates for the rest of the S&P 500 provides a blended profit increase of 3.5% compared to a year earlier, according to FactSet.
If that number stays in the black after all companies have posted their earnings, it will mark the third straight quarter of year-on-year earnings increases for the S&P 500.
Related: $776 million fund manager finds bargains in small-cap stocks
Also, 77% of S&P 500 companies reporting results so far have posted a positive surprise in earnings. Of course, that’s not too big a deal, as it’s common for companies to find ways (usually perfectly legitimate) for their reported numbers to outstrip expectations.
Until April’s market correction, Wall Street analysts were jumping to increase their full-year stock forecasts.
Are stocks too pricey?
But all this happy, happy/joy, joy for stocks may have pushed them to unsustainable levels. Even after the correction, as of April 26, the S&P 500 forward price-to-earnings ratio (P/E) registered 20, topping the five-year average of 19.1 and the 10-year average of 17.8.
And research from legendary money manager Leon Cooperman, chief executive of Omega Advisors, shows serious negative implications for a P/E number like the present one (see table below).
Related: Should you buy bonds now? Here’s what Vanguard thinks
From 1961 to 2019, at times when the forward P/E ratio registered 20 to 22, annualized returns (including dividends) for the S&P 500 totaled negative 1% for the next year, positive 3.5% for the next three years, and positive 1.9% for the next five years.
If the future matches the past, those statistics don’t augur well for stocks over the next few years.
Research shows that high-flying price-earnings ratios aren’t good for stocks.
TheStreet
Doug Kass’ take on stocks
One respected investor who’s bearish on stocks is TheStreet Pro’s Doug Kass. Kass is a hedge fund manager whose career dates back to the 1970s. He was research director at Cooperman’s Omega and now runs the hedge fund firm Seabreeze Partners.
In addition to lofty valuations, he listed these dangers for the stock market:
Rising geopolitical risks, such as the Mideast conflict and war in Ukraine.Higher interest rates for longer. The Fed predicts that will be its strategy in the months ahead.Prickly inflation and slowing economic growth — “slugflation.”Reckless fiscal policy that has led to an ever-larger budget deficit and cumulative U.S. debt load.
Fund manager buys and sells:
Cathie Wood buys $22 million of battered tech stockFund manager of $100 million long/short mutual fund explains pair trade strategyGoldman Sachs revamps conviction list after stocks soar in Q1
None of this, of course, means that stocks can’t keep rising. It could be that the economy rolls along and inflation resumes its downtrend. That could push earnings higher, which could, in turn, keep stocks in their current ascent.
However, you should be aware of risks that could cause a market correction and be prepared for them.
Related: Veteran fund manager picks favorite stocks for 2024
