This is a macro driven market. So even as the S&P 500 Index nears a bear market, until we get better news on the macro front, volatility will likely continue. There is a long list of macro worries right now, including sky-high inflation, rising interest rates, an aggressive Federal Reserve, a possible U.S. recession, China’s ongoing COVID-19 lockdowns and resulting supply chain disruptions, and war in Ukraine. So while we believe that stocks generally offer good value relative to companies’ earnings power with the S&P 500 Index near 3,900, that value may unfortunately take more time to be realized.
Once economic conditions begin to improve, earnings will start to matter again. The combination of growing earnings and more attractive valuations can be powerful. Companies have broadly demonstrated that they can grow earnings at a solid pace despite these intense cost pressures, even though there have been signs that the environment has been getting more challenging for certain industries, particularly retail. When those pressures start to abate, earnings will strengthen and get more attention. For longer-term investors, that earnings power will provide a solid foundation for higher stock prices.
“The bears might say that stock valuations are not attractive because the earnings may not come through,” noted LPL Equity Strategist Jeffrey Buchbinder. “But corporate America has a profit margin problem, not a revenue problem. And the causes of those margin pressures are likely to abate in the second half of the year.”
U.S. earnings continue to stand out globally
U.S. stocks are trading at more expensive valuations than their international counterparts, as they have been for quite some time. However, the chart below illustrates the continued earnings superiority of the U.S. equity market, which suggests that U.S. outperformance over the past year has been justified. While international stocks have outperformed the U.S. over the past couple of months as the selloff in domestic tech stocks has accelerated, we would expect U.S. equities to lead the rebound on the other side.
While earnings estimates for U.S. equities have continued to rise in recent months, albeit gradually, expectations for international earnings in both developed and emerging markets have been reduced. Stronger earnings growth potential and less impact from the Russia-Ukraine conflict still support our preference for U.S. equities over Europe, which makes up the majority of the developed international markets benchmark. We are watching for more geopolitical stability and a weaker US dollar to potentially get more interested in international equities from a tactical perspective.
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