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SUMMARY
- Corporate pricing power helping margins, in our view.
- Market Valuations: Reasonable to us…if earnings hold up.
- Market Valuations: Market not in ‘bubble’ territory yet, in our opinion.
We are excited to release our July 2023 Chart Pack – our visual quarterly designed to walk investors through our views on:
- What’s happening and why,
- Predictions about what may come next,
- Positioning in our RiverFront portfolios.
In today’s Weekly View, we created a concise synopsis of three selected visuals from our July 2023 Chart Pack. In aggregate, these visuals paint a relatively constructive picture of US corporate margins and earnings… and lay out why we believe stock valuation is not a major near-term headwind for the market. Given these views, our balanced asset allocation portfolios favor stocks over bonds, with an emphasis on the US. We increased our equity weighting in the 2nd quarter, as our views on earnings fundamentals and technical trends improved.
Corporate Pricing Power Helping Margins, in Our View
A rough proxy for corporate pricing power can be seen by studying the relationship between inflation rates in consumer prices (as illustrated by the Consumer Price Index, or ‘CPI’) and inflation rates in input prices for companies (represented by the Producer Price Index, or ‘PPI’).
Note that, for the first time in roughly 2 years, CPI is higher than PPI, and by a wide margin. This suggests to us that companies are successfully raising prices on consumers (see chart below) and protecting profit margins.
Market Valuations: Reasonable to us… if Earnings Hold Up
The S&P 500’s valuation is roughly 19x 12-month forward earnings estimates…about 3 points cheaper than at the start of 2022.
However, we believe this reasonable valuation may be a mirage if earnings subsequently collapse. Recently, 12-month forward earnings forecasts stabilized after dropping roughly 5% from their high last summer…and are now strengthening again.
We believe earnings estimates will prove resilient from here, and that the stock market has already seen its low for this cycle.
Market Valuations: Market Not In ‘Bubble’ Territory Yet
Strong earnings and Artificial Intelligence (AI) buzz helped drive the tech-heavy S&P 500 back above historical average valuations, in our view. Despite the recent rally, the S&P 500 does not appear dramatically overvalued to us.
While 19x is at the upper end of valuations during non-recessionary periods, it is not anywhere near the 22-24x range seen at the height of the ‘Tech Bubble’ period from 1998-2000 (chart right, shaded region).
Conclusion:
We believe the market’s recent strength is justified by current fundamentals; thus, we favor stocks over bonds in our balanced portfolios.
Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.