Monthly Outlook: August 2023
Markets continue to trend higher, and portfolios are growing. For all the nervous talk about interest rates, recession, inflation, and other risks, the markets just don’t seem to listen or care. The Magnificent Seven big technology companies certainly sparked the initial excitement earlier this year, but the optimism has spread to other markets and now almost every market and sector is moving higher. This summer, the trend is our friend and we’re fully invested to capture the available growth.
It’s a good time to remember that the market is not the economy. And we invest in the market, which can, and often does, act in counterintuitive ways to the fundamentals and economic data. Yes, the Fed has raised interest rates from 0% to 5.25% over the past year and that should slow the economy. Yes, inflation is still too high at 4% to 5%, depending on which indicator you use, and that’s a long way from the Fed’s 2% target. Yes, unemployment bottomed out at 3.4% this spring and is creeping higher at 3.6% today. The list goes on. But markets trade on investors’ expectations about the future, about 12 months out. So, this year’s uptrends across markets suggests that the economy is going to be better, not worse.
S&P500 Earnings
Let’s look at the earnings of the S&P500 companies. After all, investors in stocks ultimately are buying the earnings and dividend stream of the company’s stock they’re buying. Over the very long run, a stock’s price should move higher in relationship to how the company’s earnings grow.
Analysts often talk about the S&P500 index as if it was one stock that represents the overall U.S. stock market. The price of the S&P500 index is $4,589/share. The earnings of the S&P500 index peaked at $198/share in March 2022. With the economic slowdown last year, earnings fell to $173/share by December 2022, down 12%. And you might remember that the S&P500 index fell by 20% last year. That makes sense, right? Earnings were down, so stock prices went down. Next, let’s look at stock prices and earnings for this year. We’re halfway through 2023, and earnings are still flat, at about $178/share. Yet, prices have rebounded 20% this year. Why would prices be up 20% when earnings are only up 2%?
The answer takes us back to the concept that stocks trade on expectations, not today’s realities. Analysts (collectively) forecast that S&P500 earnings will be $197/share by the end of 2023, and will continue to expand to $221/share by the end of 2024. That’s right, they expect 24% higher earnings 18 months from now, which partially explains why stock prices are already 20% higher this year. Whether you or I believe that is possible or realistic is moot. “The market” decides the price and we just get to decide what to do about it. Ryan Investments’ strategy is to invest with the prevailing price trend, and stay invested as long as the trend is up.
No Need to Guess
All day long, competing analysts and pundits argue about whether S&P500 earnings will grow 24% by next year. They argue whether the Fed will raise rates again, whether inflation will recede, whether we’ll avoid a recession, and so on. No one can really know in advance, so they argue/debate, and they guess.
We think there’s a better way. Price, assuming a fair and open market, always represents the collective thinking of all participants. Is that house really worth $15 million? If it sold for that, then apparently it is. Is that airfare really worth $1,500? If the plane is full, then apparently it is. It’s the same with stocks and bonds. As long as the price remains above its moving average price trendline, then we define that market as uptrending. It’s just math, and we can measure the price and price trendline every day. We can visualize it using charts.
Today, nearly every market is trending higher and that’s our signal to remain fully invested. When, not really if, any market turns down below its constantly moving trendline, we’ll sell and protect our gains. We don’t have to believe S&P500 earnings will grow 24%, or not. We don’t have to predict a recession, or not. We’ll just follow the trends and invest accordingly.