Stocks on Wall Street fell last night (Tuesday) ahead of the Federal Reserve’s next policy decision, as investors grappled with the effects of rising interest rates on corporate earnings and valuations.
The central bank is expected to sharply raise interest rates again this evening (21:00 Israel time) in an attempt to moderate inflation, a move that will ultimately slow down the economy and probably hurt corporate profits. At the same time, higher interest rates will limit the prices investors will be willing to pay for a slice of those profits.
These obstacles could make it difficult for the major stock indexes to break out of the slumps they’ve been in for nearly three quarters of 2022. S&P 500 Down 19% this year, and the rise in interest rates is eating away at the high valuations that stocks enjoyed for most of the pandemic.
The S&P 500 fell 1.1% yesterday, and all 11 of its sectors ended the day in the red, while US government bond yields again climbed to new multi-year highs as the prices of the bills fell.
Almost a fifth believe the Fed will raise interest rates by one percent
Traders pegged the probability that the central bank will raise interest rates by 0.75% at the end of today’s meeting at 82% and an 18% chance of a full percentage point increase, according to FedWatch, an instrument operated by the CME Group.
Evidence last week that inflation accelerated in August despite the Fed’s aggressive rate-hiking campaign dashed any hope that the stock market would change direction. The data showed a high monthly increase in the core prices for consumers, which do not include food and energy prices, as well as a higher than expected annual inflation. That prompted traders to bet the Fed would raise interest rates faster and sent stock indexes down for their worst day since 2020.
“This news really took the wind out of the sails of a lot of investors who had hope that inflation was going to come down,” said Tim Courtney, chief investment officer at Exential Wealth Advisors, an Oklahoma City firm that manages about $3.7 billion.
After the big and brutal selloff of 2022, stock prices are lower compared to earnings (earnings multiples). The S&P 500 index is trading at 16.6 times expected earnings in the next 12 months, down from a multiple of 21.5 at the end of 2021 and less than the 10-year average, according to Fact Set.
Higher interest rates can make investors even less willing to pay high prices for parts of companies’ future earnings. And as higher interest rates seep through the economy and hurt growth, many investors think that incomes are becoming increasingly vulnerable. In recent months, analysts have cut profit estimates for the coming quarters.
John Porter, chief investment officer and asset manager at Newton Investment Management, said stock valuations could shrink further, but he is particularly concerned about earnings. “This combination of earnings concerns, which are most important to me, with a little pressure on valuations – it’s just math, it’s a tough combination for the market environment in the short term,” he said. He also added that he keeps slightly higher than usual levels of cash in the portfolios he manages.
The company’s profit growth forecast was reduced
As more and more companies report their performance, investors will be looking to understand how tighter monetary conditions and continued inflation are affecting the bottom line. Revenue expectations in the third quarter will decrease in the coming months in many areas, from technology to industry and finance.
Analysts expect the profit of companies in the S&P 500 index to rise 3.3% compared to last year, down from forecasts for growth of 9.9% on June 30, according to FactSet. Growth estimates for 2022 dropped from 9.6% to 7.7% during this period.
Analysts are already looking at the first trickle of quarterly reports released this week by several companies, including Cheerios breakfast cereal maker General Mills, Olive Garden parent Darden Restaurants and delivery giant FedEx.
stock fdx They fell 21% on Friday, their biggest daily drop, after the company said quarterly revenue fell short of expectations and that it planned to close offices and ground planes in response to a drop in shipment volume. The company’s announcement heightened concerns about the health of the economy and hurt the market more broadly, contributing to the S&P 500’s worst week since June.
Some money managers say the decline in valuations has left stocks more reasonably priced — and increased the potential profit they offer today’s investors.
But when there are reasons to think that the Fed will continue to raise interest rates and when past increases are not yet fully felt in the economy, many fear that it is too early to bet on a prolonged rally in stocks.
“If you think you should buy stocks in the darkest hour before dawn, then I’d say we’re still about 2 a.m.,” said Irene Dunkel, chief U.S. equity strategist at BCA Research. “We’re still going to see the effects of policy tightening. We’re going to see how much the economy will shrink.”