- April 20, 2022
- Blog , CJ Lawrence , The Portfolio Strategist - Terry Gardner
Earnings are OK but Rising Rates Weigh on Stocks, Terry Gardner, C.J. Lawrence Market Comment 042022 – YouTube Video & Transcript
Terry Gardner (00:02):
Hey, good afternoon everyone. It’s Terry Gardner from C.J. Lawrence. It’s Wednesday, April 22nd. Coming to you from Midtown Manhattan with some brief market commentary as we kick off the first quarter, 2022 earning season in a relatively volatile market. So we’ve got four points to our call today. First, we want to discuss the current outlook for earnings and interest rates, two of the most important determinants of stock prices in our view. Number two, we want to look at sector leadership inside the S&P 500 Index inside the market. And then thirdly, we want to share some of our thoughts on the outlook for the economy and for the market, looking out into the back half of 2022 and early 2023. And then share some statistics on stock market returns with you.
Terry Gardner (00:51):
So first off with regards to earnings and interest rates, on the earnings front, it’s still early in the first quarter earning season. But results are coming in ahead of expectations at a good clip. Only about 61 companies out of the S&P 500 have reported, but 80% of those have reported positive surprises. So that’s good momentum, that compares to 75% positive surprises in the last quarter. So earning season is off to a good start so far in the first quarter for the first quarter results of 2022. And earnings expectations are being ratcheted higher for both 2022 full year and 2023. So those are good underpinnings for stock prices when earnings expectations continue to rise. And we haven’t seen a chink in the armor there, earnings expectations continue to be ratcheted higher.
Terry Gardner (01:44):
Countering that has been the rapid rise in interest rates, which has weighed on the market and created a lot of volatility. What we like to look at is kind of two models specifically. The first is we like to look at the earnings yield versus the treasury bond yield model. And what that measure is the earnings yield on stocks, which is the inverse of PE versus the yield on 10-year treasuries, and just to show the balance between the two. Over a long period of time, that ratio of earnings yield to treasury bond yield has averaged about 1.8. Since the financial crisis, that ratio has exceeded 1.8 every quarter since and has been much higher, as high as 2, even 3, 4 times in terms of the ratio. Interestingly, as of last week, that ratio dropped below 1.8, to 1.75. So that’s the first time we’ve seen that ratio decline below the average since the beginning of the financial crisis. And that’s probably something to watch. Again, that’s kind of comparing the earnings yield on stocks versus the yields you can get on bonds and the parody between the two.
Terry Gardner (03:01):
And another model that we like to look at in that same regard is how fast are those interest rates rising in the long end? So we have a 30-day rate of change model, and simply what it looks at is where is that 10-year yield today versus where it was 30 days ago. So it just measures the pace of change. And we’ve noted in the past that when that 30-day rate of change eclipses 25%, it tends to peak out shortly thereafter. And then the stock market tends to perform much better in subsequent periods. We thought we’d achieved that 25% rate of change back in February.
Terry Gardner (03:48):
But interestingly enough, with this latest surge in rates, the 30-day rate of change has now eclipsed 60%, which is at an all-time high. So we’re seeing rates today over 60% higher than where they were 30 days ago. That’s quite remarkable. Clearly, it weighs on stock prices. I think one could probably make the case that it’s remarkable to see how well stocks have held in there despite the rapid rise in interest rates. So those are two models that were watched going into the belly of two of 2022.
Terry Gardner (04:28):
Secondly, we wanted to look inside the index to see whether the sector leadership confirmed some of that broader macro backdrop, and to an extent it does. The leaders on a year to date basis, on a sector basis within the index have been energy, consumer staples, and utilities. All three would be considered to have safety and defensive characteristics. So as bond yields are eclipsing stock earnings yields, you could expect the market to become a little more defensive. And in fact, that’s what we’re seeing inside the market.
Terry Gardner (05:06):
So, thirdly, I want to highlight a couple of things that we think could change to the market dynamics in the back half of 2022 and 2023. I think the consensus belief and it’s ours as well, is that the Fed will remain very aggressive in raising interest rates to combat inflation, and that has implications, but I think the Fed wants to be aggressive now in the case that they need to ease off later on. And I think there’s a good case that can be made that that’s in fact what will happen. So the Fed will likely raise rates until they start to see warning signs. And what could raise some of those warning signs? I think we’re starting to see the seeds of them now, particularly with regard to slowing economic activity in Europe. We could spend an entire video talking about what’s going on in Europe and the challenges that their economies are facing from a geopolitical nature and from an energy consumption perspective.
Terry Gardner (06:11):
But let’s just assume that Europe will continue to slow through the back half from 2022. It’s clear that China is slowing. So the two largest economic regions in the world are slowing. And it’s likely that in the back half of this year, some of these supply constraints that we have been facing, whether it’s regarding manufactured goods, durable goods, like washing machines, dryers, refrigerators, or semiconductor chips. Some of those supply chain challenges will start to abate. And at the same time, as the Fed is raising rates in the US, you could see some tempering of economic activity in the US. So between Europe slowing, and China slowing, the potential for the US to slow. And at the same time, seeing supply chain pressures abate, you could have this dynamic whereby demand is slowing and supply is increasing.
Terry Gardner (07:14):
And that, some have felt could potentially bring on a recession. It’s probably more likely to bring on slower growth in the back half of this year and into 2023 at a minimum. And under that type of a scenario, stocks that rely on a strong and improving economy for a boost, for a lift, tend to underperform. And it’s the stocks that have a tailwind or secular tailwinds that are disruptors and creating new markets and dominating their industries and gaining market share. Those are the stocks that tend to perform well in those environments. So we could potentially see that shift starting to take place in the second half as all these macro factors kind of come together. If you’d like to discuss which stocks fit into those, into that category, feel free to give us a ring. We’re happy to chat about that.
Terry Gardner (08:15):
And then finally, I wanted to share some total return statistics with you regarding market entry points. And I’m raising this now because I’m getting this question a lot. As the market has been somewhat volatile, many have asked me, “Hey, is now the right time to be invested? Is now the right time to open an account and invest?” And we’ve consistently said, and others have as well that it’s very difficult to time the market. But with the benefit of time, equities are the best asset class that you can own over periods of time. And I did this exercise because I wanted to show some of my clients the facts and figures around this. If you bought it at the wrong time. So just looking back to the financial crisis, and I think I may have shared some of these statistics with you before, but we’ve kind of redone this exercise using current prices.
Terry Gardner (09:07):
If you bought at the very worst time prior to the financial crisis in 2008. So if you bought at the peak in 2007 and held, you certainly would’ve had to withstand the recession and the financial crisis in 2008, 2009. But you’d be up 280.3% today in total return if you bought the S&P 500. Clearly, you would do better if you had bought the better-performing stocks and groups within the index. We had a large drawdown, if you remember in late 2018, that actually reversed itself right around Christmas Eve in fact, the market was down 28% during that period. If you had bought prior to that downdraft. So the worst time, at the peak, which would’ve been September 28th of 2018 before the market dropped, you’d still be up 60.3% today. And then finally, if you had bought the week before we started to experience COVID close down here in the United States in March of 2020. So if you had bought in late February of 2020, at the peak before of the market tailed off, you’d be up 37.1%.
Terry Gardner (10:19):
So the point is that even if you don’t time the market particularly well, with the benefit of time, stocks are an incredible asset class to be invested in from the perspective of total return. So if you have any questions about this data or any of the other topics that we covered today, please feel free to give me a ring at 212-888-6403 or email me at tgardner@cjlawrence.com. Look forward to your calls and your emails, and look forward to speaking with you soon. Thanks and have a great day.