Valuations and guidance appear foreboding for U.S. equities
The month-long rally in U.S. equity markets hit stiff resistance in mid-August. Surprising resilience in economic data, including consumer spending, employment and July’s cooler-than-expected Consumer Price Index report, helped propel broad-based indexes like the S&P 500 and the tech-heavy Nasdaq out of their bear market lows of June and in to bull market territory.
- Bear market rally or something more sustainable? While this summer’s equity market rally was largely driven by relatively positive economic news, Fed Chair Jerome Powell made it clear with his comments in Jackson Hole that it’s entirely too early to declare victory in the U.S. Federal Reserve’s fight against inflation. With more hawkish policy expected from the Fed and uncertainty still heightened, we’re likely to see further retracement of this summer’s bear market rally – and perhaps even retest the lows seen in mid-June.
- Valuations and guidance appear foreboding. As of 22 August, the S&P 500 forward 12-month price-to-earnings (P/E) ratio sat at a 5% premium to its 10-year average. Meanwhile, earnings growth slowed to the lowest level since 2020 (+6%) and was negative (-4%) when excluding the energy sector. Further, an increasing number of companies have lowered their fiscal year earnings guidance (more than 50% of the roughly 250 reporting). As a result, valuations should offer little support for current price levels over the near term.
- Portfolio impacts. All in all, we believe that equity markets will continue to offer investment opportunities for investors focused on companies with strong earnings growth and pricing power that can help overcome inflation and expand margins. Broadly speaking, we favor higher quality stocks with steady earnings and strong cash flows. More specifically, in a risk-off environment we are identifying opportunities within health care, due to the sector’s growth orientation and trustworthiness among investors, as well as among dividend growers thanks to the more stable aspect of income as a part of the total return equation.
Index Performance: FactSet; European Corporate Earnings: I/B/E/S; U.S. Corporate Earnings: Standard & Poor’s; Employment: RBC Global Asset Management; Russell Indexes: FactSet, Russell Investments.
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A word on risk
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