Stocks don’t need a reason to collapse. Don’t hesitate to rule out Monday’s 2% drop in the
like a statistical half-sneeze. Since 1950, the index has averaged two 5% declines per year, according to Lindsey Bell, chief investment strategist at Ally Invest.
But laying the blame is more satisfying, and two easy culprits stand out: a Covid-19 surge and maximum growth.
Cases of Covid-19, especially the fast-travel Delta variant, are on the rise in many parts of the world. Will this lead to further widespread blockages?
says no, because mortality has gone down. But the effect on growth is unclear. I booked a trip for a family vacation at the end of August, and now cases of the virus are increasing at our destination. We haven’t canceled, but we don’t rule it out. Assuming we’re not the only ones waiting, Delta could further reduce demand, even without foreclosure.
With or without more cases of Covid-19, the year-over-year profit growth rate is surely achieved. The second quarter of 2020 was the first quarter of complete foreclosure and a terrible one for the company’s results. Against this easy comparison, Wall Street predicts that companies in the coming weeks will post earnings growth of 63% for the second quarter of this year. But for the third quarter, the estimate is much lower, 23%, and more important than the slowdown in growth could be as upward revisions to earnings estimates have gotten smaller.
“While we don’t expect to see earnings drop anytime soon, we are definitely at an inflection point,” CIBC Capital Markets market strategist Ian de Verteuil wrote in a recent note to investors. “It wouldn’t surprise us if the magnitude of earnings surprises moderates.”
One culprit to be ruled out is inflation. A sudden surge in consumer prices that started three months ago has left some investors wondering if bond yields will rise, attracting equity investors and reducing stock valuations. But now the 10-year Treasury yield has fallen to 1.2% from 1.6% in the past three months. The bond market appears extremely confident that faster inflation rates will not hold up – so confident that it raises questions about the economic recovery.
As for what equity investors should do, Wall Street has advice for everyone. Be on the defensive,
Strategist Michael Wilson urged on Monday, raising the consumer staples sector from neutral to overweight, and calling stocks of Mondelez, the maker of Oreo and Ritz cookies, as particularly attractive. “Boredom can be fine if the big market starts to falter,” Wilson wrote. He also named the healthcare, real estate investment trust and telecommunications sectors as now well positioned. He downgraded the materials to Neutral.
But JP Morgan strategists argue that investors have too quickly turned away from stocks that are benefiting from the economic reopening. “We are waiting for the reflation trade. . . imminently rebound as Delta variant fears subside and inflationary surprises persist, ”they wrote on Monday.
Here is some good news: de Verteuil of the CIBC points out that the S&P 500 has returned 10.4% per annum during the 15 years ended in 1988, while the inflation rate was on average 6.6%; then 13.6% over the next 15 years, with average inflation of 2.7%; then 11% over the next 15 years, with an average inflation of 2%. His argument is that stocks can withstand various economic contexts.
Even after Monday’s decline, the S&P 500 is trading at 22.6 times this year’s projected earnings, which is expensive relative to its history, so don’t expect average double-digit returns in the years to come. come. But whether you find the Cyclical or Oreos arguments more compelling, don’t shy away from stocks. Bonds are handy in a pinch, like Monday’s liquidation, but the 10-year Treasury is paying four percentage points less than the last inflation reading. In the long run, paying these prices for stocks is easily a better deal than that.
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