Ominous clouds hang over the stock market, and investors need to tread carefully. As we move into March, it's important to prepare for more volatility driven by the Federal Reserve and international conflicts. It's also important to keep your eyes peeled for opportunities to buy great stocks at a discount. Here are my three biggest predictions for March.
1. The market will lose support from earnings
Earnings season is just about over, which is bad news for the stock market. So far, 95% of the S&P 500 companies have reported their results for the fourth quarter. More than three-quarters of them exceeded Wall Street's expectations for sales and profits. The S&P 500's average 30% earnings growth rate has been nearly 8% higher than analyst estimates.
Importantly, consumer discretionary and technology stocks were particularly strong. These sectors tend to be volatile during turbulent markets, so these positive results probably created a lot of stability.
Image source: Getty Images.
Unfortunately, there won't be much news about corporate fundamentals in March. In lieu of that, stocks will be moving due to macroeconomic and capital market trends. That points to rocky times ahead for investors.
Interest rates are rising, the conflict in Ukraine is creating major geopolitical tension, and investors are pulling capital from the stock market in favor of lower-risk asset classes. Those factors all tend to hurt stocks, and none of them will get fully resolved in a few weeks. Economic data such as inflation, unemployment, and sentiment ratings will receive extra attention. Any of that news could go either way, but extra volatility is likely.
Even a fantastic earnings season wasn't enough to propel major indexes much higher. The market is reacting more extremely to bad news than to good news. Poor earnings reports are being punished in a larger magnitude than good earnings reports are being rewarded.
That's strong evidence of ongoing downward pressure in the market. The good news from earnings season is behind us, and anything else that's supporting stock prices is flimsy at best.
2. Updates from the Fed will be crucial
The Federal Reserve Open Market Committee (FOMC) is scheduled to meet again on March 15 and 16, and investors will be tuning into the press conference for information. Rate hikes are a hot topic as the monetary authorities struggle to contain inflation. Any indication that interest rates will rise more quickly than expected is likely to push the market downward. If the Fed's commentary suggests that rate hikes will be less extreme than anticipated, stock prices might jump upwards.
Inflation has tracked higher than most forecasts since the last FOMC meeting was held in January. That inflation data has been digested by investors, but everyone is still waiting on Fed commentary to confirm expectations. Consumer prices continue to put pressure on the Fed, so it's unlikely that the rate hike timeline will be extended.
Still, it's all about new information relative to expectations, so it could go either way -- just be ready for a meaningful move up or down in the middle of the month. Growth stocks will respond with especially high volatility.
3. There will be attractive buying opportunities in March
Valuations in the market hit unsustainable levels during the pandemic rally. Low interest rates and high-risk appetites drove stock prices near all-time highs relative to earnings, sales, dividends, book value, and cash flows. Rising interest rates and more conservative attitudes toward risk are reversing that.
The S&P 500 is nearly 10% below its all-time high, and growth stocks are bearing the brunt of the pain. Tech giants Alphabet, Microsoft, Amazon, and Apple are down at least 7% year to date. It's been substantially worse for Netflix, Meta Platforms, and Tesla.
Meanwhile, many of the pandemic darlings in the cybersecurity and work-from-home industries have fallen 20% to 30% in 2022. At some point, the valuation pendulum will swing, and price rationalization will turn into undeniable discounts. There are signs that we're getting close to that point.
The S&P 500 forward PE ratio just reached pre-pandemic levels, and it's only 10% above the long-term average level. The S&P 500's average dividend yield is also sneaking higher, as seen in the chart, even though the index is dominated by tech stocks that don't pay dividends.
SPY Dividend Yield data by YCharts
A correction that brought stock prices more in line with fundamentals was overdue, and investors shouldn't panic now that it's happening. It could be months until the market returns to regular growth, but that's just a temporary inconvenience for long-term investors. If the market keeps sliding in March, some of the hardest-hit stocks will move into "must-buy" territory.
