Battered US stocks may not be bargains as investors brace for inflation data
The fall in US equities this year puts more focus on equity valuations, as investors assess whether recently discounted stocks are worth buying in the face of a hawkish Federal Reserve and widespread geopolitical uncertainty.
With the benchmark S&P 500 down 13.5% year-to-date, valuations are at two-year lows, putting the index’s forward price-earnings ratio at 17.9 times compared to 21.7 at the end of 2021, according to the latest data from Refinitiv Datastream.
Although many investors tended to ignore lofty valuations during the market’s momentum surge from its post-COVID-19 lows, they were quick to punish companies deemed overvalued this year, as the Fed reverses easy money policies that had kept bond yields low. and supported actions.
While recently refreshed valuations may boost the equities’ appeal to some bargain hunters, other investors believe stocks may not be cheap enough as the Fed signals it’s ready to tighten aggressively. its monetary policy to combat inflation, soaring bond yields and geopolitical risks such as the war in Ukraine continues to agitate the markets.
“Equities are approaching fair valuation…but they’re not quite there yet,” said J. Bryant Evans, portfolio manager at Cozad Asset Management in Champaign, Illinois. “If you take into account bond yields, inflation, the evolution of GDP and the economy in general, they are not there yet.”
Wild swings rocked markets last week after the Fed announced a widely expected 50 basis point rate hike and signaled similar moves for upcoming meetings as it tries to rein in annual inflation rates the highest in 40 years. The index has fallen for five straight weeks, its longest losing streak since mid-2011.
More volatility could be in store if the monthly Consumer Price Index reading in the coming week beats expectations, potentially strengthening the case for even more aggressive monetary policy tightening from the Fed.
“There has … been a healthy reset in valuations and sentiment,” Keith Lerner, co-chief investment officer at Truist Advisory Services, wrote in a recent note to clients.
“For stocks to rise sustainably, investors will likely need to have greater confidence in the Fed’s ability to control inflation without unduly harming the economy.”
Although valuations have fallen, the forward P/E for the S&P 500 sits above its long-term average of 15.5 times earnings estimates.
According to data from Refinitiv, S&P 500 companies are expected to increase earnings by around 9% this year as they wrap up a better-than-expected first-quarter earnings season.
One likely factor is whether Treasuries extend a selloff that lifted the yield on benchmark 10-year notes, which is moving inversely to prices, to its highest level since late 2018.
Higher yields in particular dampen the appeal of technology and other high-growth sectors, as their cash flows are often more weighted to the future and shrink when discounted at higher rates.
The S&P 500 technology sector’s forward P/E has risen 28.5 times to 21.4 so far this year, according to Refinitiv Datastream data from Friday morning.
“In terms of growth valuations, they’ve been the hardest hit and probably the most oversold,” said Art Hogan, chief market strategist at National Securities.
But the sector continues to trade at a nearly 20% premium to the broader S&P 500, above the 15% premium it has averaged to the broader index over the past five years. last years.
If the 10-year yield swings between 3% and 3.5%, after being a “fraction” of that level for a long time, “it’s going to continue to be a drag on the P/E and therefore the mechanism of discount for the growth and technology space,” said John Lynch, chief investment officer of Comerica Wealth Management, which favors value over growth stocks.
“To a large extent (the pressure for higher yields) has been priced in,” Lynch said. “But I don’t think it’s going to go away. I think it will last. »