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There are many reasons to be optimistic about the market, even with the China wildcard


Optimism seems to be breaking out everywhere, judging by comments over the weekend. “The worst may be over for the stock market,” said Barron’s Andrew Bary, noting that the Dow Jones Industrial Average is only down 5.5% for the year, and it closed Friday at its highest level since April. As everyone knows, the Dow is price-weighted. This year, seven of the top 10 highest priced stocks are up for the year; only three (Home Depot, Microsoft, Visa) are down. The gains are due to advances in energy (Chevron), health care (Merck, Amgen, UnitedHealth) and industrials (Caterpillar, Honeywell). Technology stocks (, Microsoft, Apple) have all been a drag on the Dow. More interesting is the S & P 500 , which is down 15.5% and only 16% from its old closing high on Jan. 4. The main factor driving the rally is the hope that the Fed will begin slowing the pace of rate hikes. Chairman Jerome Powell is set to give a speech this Wednesday where he is expected to signal rate hikes will continue into 2023 but at a slower pace. Hopes that China, despite its rhetoric, will take a more reasonable stance on Covid shutdowns , has also fueled some optimism, but the protests in China over the weekend against those lockdowns could be viewed two ways. Bulls argue it will hasten the process of eventually reducing lockdowns and increase vaccination levels, but bears are arguing that more targeted lockdowns will continue. For the moment, China is a real wildcard. Elsewhere, optimism has been fueled by unusually strong seasonal factors for stocks and more reasonable valuations. The seasonal factors are well-known: 1) best six-month period for stocks began Nov. 1, and 2) there is a tendency for a strong rally following mid-term elections. Another factor helping the market may be strong buybacks from corporate America. “US Corporates demand [for buybacks] is increasing ahead of 1% tax changes,” said Scott Rubner from Goldman Sachs’ global markets division in a recent note to clients, referring to a 1% tax on buybacks that was recently signed into law. But November and December is also the strongest season for stock buybacks. According to Goldman, 21% of corporate buybacks are executed in November and December. “We are in the middle of the best two-month period of the year for corporate flow,” Rubner said. Another help for the bulls: stock market valuations are not at crazy levels. There’s been a lot of hand-wringing over the fact that earnings estimates have turned negative for the S & P 500. Fourth-quarter estimates are now expected to be down 0.4% compared with the same period a year ago, led by big declines in communication services (down 20.9%) and technology (down 7.8%), according to Refinitiv. It’s a small decline, but it’s the first quarterly decline since the third quarter of 2020, when earnings dropped 6.5%. Earnings declines are never welcome, but the stock market is a lot more reasonably valued now than the third quarter of 2020. At the end of the third quarter of 2020, the S & P was around 3,200, rallying big off the 2,237 close on March 23. That third quarter was the height of demand for goods, and the market reflected that demand. The S & P was trading at crazy multiples: roughly 26 times 2020 earnings and 21 times 2021 earnings (the long-term average is roughly 17). Today, the S & P is trading at a far more reasonable valuation of about 17.4 times 2023 earnings estimates. That is still on the high side, and certainly reflects the hope for a soft landing, but it’s not nosebleed territory. The biggest complaint now is that an historically “average” multiple may still be too high if the economy slows considerably. True, but hardly cause for panic.

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