Wall Street’s insensitivity to bad news, which allowed stocks to double in value from their pandemic panic lows, could begin to crack.
When the Federal Reserve signaled in September that it soon tighten monetary policy by limiting asset purchases, stock Exchange took it well, but not for long. The S&P 500 edged higher for a few days before reversing, pushing the index more than 5% below the high it hit earlier in the month, which was its biggest drop of the year. .
Despite this setback, the market managed to post a gain of 0.2% for the third quarter.
A tighter Fed isn’t the market’s only concern. Inflation, dismissed until recently by the Fed as a transient artifact of the pandemic, becomes more persistent as the prices of goods, services and labor rise. What is recognized as transitory, however, is the jolt to economic growth and corporate profits provided by several trillions of dollars in additional congressional spending.
With a number of threats to prosperity becoming harder to ignore, many investment advisers have become less enthusiastic about stocks. They revise return expectations downwards and recommend exposure only to narrow niches.
“We’re not bullish at all today,” said David Giroux, head of investment strategy at T. Rowe Price. “What’s really driving the market is earnings growth,” he said. “We can’t repeat some of the things we’ve done this year. Earnings growth could slow in 22, perhaps dramatically.
After being a colossal boon to the economy, fiscal stimulus — in the form of huge federal spending — may now turn out to be three problems for the stock market in one. Government spending focused on the pandemic that boosted growth is ebbing. There is a broad consensus that taxes will soon rise to help pay for these expenses. And, as many people took direct stimulus payments and invested them in the stock market, stocks rose faster than they otherwise would.
The positive effects of so much stimulus may have run its course, as domestic equity funds tracked by Morningstar lost 0.6% in the third quarter, with financials-focused portfolios among the few clear winners .
the SPDR The S&P 500 ETF Trust, which tracks the index and is the largest exchange-traded fund, returned 0.6% in the quarter, beating the average actively managed mutual fund.
The very fact that many investors, until recently, seemed indifferent to the perils facing the economy is what some find troubling.
“There is complacency in a lot of things,” said Luca Paolini, chief strategist at Pictet Asset Management. He listed some of his concerns: “’Inflation is temporary.’ May be. Maybe not. Six months ago, consumption was booming. People had money and time. Now they have less money and less time. Earnings momentum has clearly peaked from six months ago. I fear the market is pricing in the deteriorating economic outlook.
By some measure, inventory is so expensive as at almost any time in history. The S&P 500 is trading at around 34 times trailing 12 months earnings. Sarah Ketterer, managing director of Causeway Capital Management, worries that corporate earnings face many headwinds and that their impact on stocks could be particularly high at such rich valuations.
“Inflation is up, economic growth is down,” she said. “The phenomenon of supply chain disruption is global, creating cost increases and pressure on margins.” Companies in many sectors have reported difficulties in sourcing certain commodities and important components of manufactured goods, such as semiconductors, hampering production and making what they produce more expensive.
Rising prices pushed up interest rates in the bond market, pushing down bond prices and limiting bond funds in the third quarter. The average rose 0.2%, led by a 2.9% decline in emerging market portfolios.
“I’m struggling to find an area of costs that haven’t gone up, and that may continue for a while,” Ms. Ketterer said. “No one knows how long it will take to untangle the tangled supply chain situation.”
The situation seems most tangled in Asia, where many raw and intermediate materials come from. China has been the source of several disturbing recent events, including power outages that have hampered manufacturing and financial instability in the China Evergrande Groupa giant, heavily indebted developer.
Some Asian market scholars see little chance of Evergrande’s woes spreading throughout China’s financial system, let alone beyond. Matthews Asia, a mutual fund manager, said in a note to investors that mortgage lending standards in China are quite strict, with large down payments required and the packaging of securities loans sold to investors minimal.
“Evergrande’s problems are unlikely to cause systemic problems and the likelihood of this developing into a global financial problem is remote,” Matthews analysts said. But they added that restrictions could be imposed on the real estate sector in the coming quarters.
It will be OK MalikA head of equities at Nuveen, an asset manager, also doesn’t expect Evergrande to become a global problem, but she warns it’s not China’s only problem.
“The government is focusing on social issues, and part of that is leading to a moderation in the growth rate” of the Chinese economy, she said. While more expansive central bank policies would help, she added, “we think China might get worse before it gets better.”
Funds that focus on Chinese equities deteriorated in the third quarter, falling 13.8%. International equity funds in general lost 2.9%.
As prices and risks in domestic and foreign stock markets increase, opportunities for strong and relatively safe gains shrink.
Mr. Giroux said he was “buying what the market is concerned about in the short term,” such as stocks of managed care providers, which are trading at a discount to the market because earnings growth has been subdued.
He said he would avoid smaller companies, as well as companies that have benefited from fiscal stimulus packages, including automakers, heavy industrial firms and semiconductor makers.
Ms Malik, who said she was “moderately optimistic” overall, favors smaller companies and European stock markets. She also likes desktop software makers, such as Salesforce and HubSpot, and high-quality consumer cyclicals like Nike.
Mr. Paolini also favors European equities.
“The case for Europe is quite strong,” he said. “Vaccination rates are high; the Covid story is over,” but government stimulus continues across the region, so “they don’t have the same fiscal cliff as the US and UK”
His other recommendations include financial stocks, which tend to benefit from higher interest rates, and drugmakers.
Ms Ketterer thinks there is more potential for pandemic recovery stocks to appreciate. In particular, she expects Rolls-Royce, which makes jet engines, to benefit from operational restructuring, and Air Canada, which has cut costs during the pandemic and has a strong balance sheet and few competition, is doing well as travel resumes.
Ms. Ketterer remains resolute in trying to pick winners when there may not be many winners to choose from.
“What are we doing?” she says. “We are not going to hide. We don’t want to be in cash and we don’t want to be in bonds if rates go up. »
Giroux said he doesn’t care much about bonds or cash – money market funds – right now either. He favors bank loans, variable-rate securities created by pooling the loans that banks have granted to corporate clients. They yield close to 4%, and that could increase if market interest rates rise. The risk of default is mitigated because bank loans occupy an important place in the capital structures of companies.
The stock market’s troubles of late are barely a halt when viewed on a chart of the phenomenal past 18 months, so a single-digit percentage return might seem like a small stretch. But that may start to look generous if the time has come for investors to learn to live with less.
“The risk profile for equities over the next three to five years is not as good as it was a year ago, as valuations are high, sentiment is good and earnings growth is expected to slow,” he said. Mr Giroux. “We reduce risk assets when things are going pretty well, and right now things are going pretty well.”