Just about everyone has looked like a genius in the stock market over the past year-and-a-half. Economic news and corporate earnings were generally positive, and investors were throwing money into the stock market to counteract inflation and low interest rates.
This shouldn't be a big cause for worry, though. When ominous signs appear in the stock market, it opens the door to investors who want to buy and hold. Consider the long-term opportunities that will be available if we have a rocky November.
There are at least three predictions about the market that can be made based on what we've seen so far. They are:
1. Signs of fundamental weakness will drag on markets
For about a year, investors have been encouraged by signs of economic recovery and phenomenal corporate earnings. Things have looked relatively smooth for stocks, and companies across a number of sectors have been smashing estimates while growing at a record pace. That growth momentum is being challenged, and corporate profits are squeezed.
We're seeing some early signals that business fundamentals are about to get choppier. The latest employment report showed continued high and rising weekly unemployment claims. That sounds like troubling news, but there are also historically high numbers of job openings. It also appears that a huge number of workers recently left their jobs voluntarily. High demand for labor is a sign of a healthy economy. However, we're clearly in the midst of a major reshuffling. People are relocating, changing careers, and starting (or closing) businesses, all of this takes time to sort out. In the short term, that can have an adverse effect on consumer spending.
This quarter's corporate earnings reports have been mostly positive, but a trend will worry some investors. Sales growth is slowing, and more companies are falling short of analyst estimates than we saw earlier this year. Even stocks that are maintaining strong sales growth are incurring higher expenses due to supply chain issues and labor shortages, which is impacting profitability. Notably, consumer stocks are among the worst performers relative to expectations, especially with cyclical and discretionary goods. That's a bearish signal for short-term economic growth.
Don't expect economic news and earnings to foster smooth sailing across the whole stock market in November. Some big names are going to feel turbulence.
2. Macro conditions will also weigh down the markets
Many of the capital market forces that have been driving stock market returns over the past 18 months are also drying up or reversing.
The Federal Reserve's injection of capital into the economy led to low interest rates and high inflation. These conditions encourage capital to flow into the stock market, and away from bonds and cash. This environment drove the S&P 500's forward P/E ratio to its highest level at any time outside of the dot-com bubble, while the S&P 500 average dividend yield did the exact opposite. Stocks are expensive relative to the cash flows that businesses are producing. That's no reason to panic on its own, but the door is open to increased volatility as conditions normalize.
The Fed's support is about to go away, as the central bank reduces its bond purchasing activity. Over time, this will cause interest rates to rise and inflation to fall. Those won't be good for short-term stock market returns, as investors will move more capital to bonds and cash.
So, what's left to drive the market higher? Corporate fundamentals seem likely to cool over the next quarter. Economic conditions aren't funneling as much capital toward the stock market. It's time for investors to really identify and stand by their high-conviction stocks, and brace for potential volatility.
3. Earnings season will create opportunities
Corporate earnings were on fire in the first half of the year, as record numbers of stocks were beating earnings estimates by record amounts. Third-quarter earnings season hasn't been as impressive so far. It's not all doom and gloom out there. Some companies are reporting stellar earnings results that are driving big gains. Still, the nearly universal momentum from earlier this year is dissipating.
With marketwide catalysts fading, the impacts of good and bad news on specific stocks are amplified. In the last week of October, Apple (AAPL 1.48%) share prices fell nearly 3% following a disappointing earnings announcement. Rival tech giant Microsoft (MSFT 3.07%) exceeded revenue and earnings expectations, driving the stock price nearly 7% higher and surpassing Apple as the most valuable company on public exchanges.
We're talking about valuation swings in excess of $100 billion based on a single quarter of results and some forward-looking short-term commentary. With capital markets in their current limbo, it doesn't take much news to trigger huge moves in the stock market. Rather than seeing all stocks declining or rallying, there's a good chance that there will be big differences between the winners and losers as earnings season rolls along in November.
Times are uncertain, and stock market conditions are unusual. That's not necessarily a bad thing. In fact, it could present opportunities for savvy investors. You'll need skill, patience, and discipline if you want to navigate these waters.
Long-term investors can't let these wild swings impact their strategy too much. If you loved a stock's growth prospects over the next five years, then this quarter probably hasn't completely changed that narrative. At most, you should add to a position of a stock that tumbled too far, or redeploy some of the gains from a winner that surpassed your valuation thresholds. Overall, though, you want to maintain your long-term allocation and ride out the temporary storm.