Stocks showed signs of life last week, with the S&P 500 rising 6.5%.
Several strong earnings reports and buoyant news on consumer spending made investors feel a bit more comfortable about stocks.
But that doesn’t mean the market is out of the woods. The S&P 500 index has slid 13% so far this year.
Morgan Stanley Chief Investment Officer Michael Wilson for one is skeptical that equities have escaped their downturn.
“Last week’s strength will prove to be another bear market rally in the end,” he wrote in a commentary cited by Bloomberg.
“The key fundamental call we are focused on now is slowing growth, and our view that earnings estimates are too high.”
The economy shrank at an annual rate of 1.5% in the first quarter, though economists largely shrugged off the decline, as it reflected decreases in inventories and exports.
Consumer spending, which accounts for more than two-thirds of economic output, rose 3.1%.
Some market participants attributed last week’s stock rally to the possibility that the Federal Reserve might take a break from rising interest rates at its September policy meeting, Wilson noted.
Inflation ‘Too High’ for Fed
“Inflation remains too high for the Fed’s liking, and so whatever pivot investors might be hoping for will be too immaterial to change the downtrend in equity prices,” he said.
The Fed’s favored inflation indicator, the personal consumption expenditures price index, soared 6.3% in the 12 months through April.
The central bank started raising interest rates in March and has gone 75 basis points so far. Many experts expect the Fed to lift rates another 50 basis points in each of its June and July meetings.
Meanwhile, Wilson predicts the S&P 500 will hit 3,400 by August, an 18% fall from the recent level of 4,150.
Looking at earnings, with 97% of S&P 500 companies having reported first-quarter numbers, the blended earnings growth rate for the S&P 500 is 9.2% from a year earlier, according to FactSet.
“Blended’ means the number includes forecasts for companies that haven’t reported yet.
If that 9.2% rate holds once every company has reported, it would be the lowest result since the first quarter of 2020.
Earnings Trouble?
Earnings growth could keep shrinking if the Fed is unable to get inflation under control or if its rate hikes put a serious dent in demand.
Another issue for the market is valuation. The S&P 500’s forward price-earnings ratio stood at 17.1 as of May 27, according to FactSet.
That’s well above the 20-year average of 15.5.
Stocks have generated returns far in excess of their historical averages in recent years, so a simple return to average could entail subpar returns for years.
The S&P 500 has returned an annualized 14.41% over the past 10 years, according to Morningstar.
That compares to 10.67% for the period from 1957 through Dec. 31, 2021, according to Moneychimp.
The index was bumped up to 500 stocks in 1957.
