Even as stock prices fell, the earnings half of the P/E equation remained relatively resilient. Now that Wall Street analysts are cutting earnings estimates at a faster-than-usual pace, some investors are bracing for another round of stock market volatility, according to a media report.
“It’s hard for us to argue that the market is cheap,” said Rob Haworth, senior investment strategist at US Bank. “We haven’t seen the end of the return to earnings yet.”
The third-quarter earnings per share estimate, a set of consensus forecasts for individual companies in the S&P 500, fell 2.5% in July, according to FactSet. That’s the biggest decline in the first month of the quarter in more than two years and a bigger drop than the historical average, the Wall Street Journal reported.
The market valuation is also on the rise. After slipping from highs at the start of the year, the S&P 500 trades at 17.5 times expected earnings over the next 12 months, up from 15.3 in mid-June and slightly above its decade average.
“It’s not just the fundamentals or the growth, but what you pay for them that ultimately matters,” said Ronald Saba, senior portfolio manager at Horizon Investments. “Valuations will be increasingly important, especially in an environment of slowing growth,” the Wall Street Journal reported.
Next week, investors await consumer and producer price reports for the latest inflation reading.
Recent data releases and corporate earnings reports have given mixed messages about where the economy is headed and whether a recession is on the horizon. Gross domestic product contracted for two straight quarters, but Friday’s robust jobs report showed unemployment remained low and the economy was adding jobs in a healthy contraction.
Expectations for corporate earnings are falling. That means the stock market is at risk of appearing expensive again, even after this year’s decline, the Wall Street Journal reported.
Wall Street often uses the ratio of a company’s stock price to its earnings as a gauge of whether a stock looks cheap or overvalued. By that measure, the market as a whole has been particularly expensive over the past two years, when easy monetary policy has pushed major stock indexes to dozens of new highs.
This environment is gone. Concerns about inflation and the path of Federal Reserve rate hikes have roiled markets, along with debate over the appropriate value of stocks. The S&P 500 is down 13 percent in 2022, despite a 13 percent rally since mid-June, the Wall Street Journal reported.
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