Could this be the most-hated bull market ever? Even as the S&P 500 climbed more than 20% since the October 2022 low, doubts and scepticism have accompanied the rise. And of course, that is as it should be – nothing in markets should be taken for granted. A surge in bond market yields brought that home over the last couple of weeks. So let’s have a quick look at some of the key issues that continue to eat away at investor confidence.
Five key issues that keep many on the sidelines:
- Earnings season could reveal nasty surprises.
- The yield curve inversion is deepening.
- Global markets are skittish, especially China.
- Higher for longer rates are doing damage.
- US stock valuations are expensive.
Due to space constraints, we’ll limit discussion of each point to only a very broad general comment without delving any deeper – in truth, each of these issues demands in depth analysis on their own. But Quick Bites are meant to be quick, so here goes…
1. Earnings season could reveal nasty surprises
Source: FactSet, WSJ
Earnings season in the US kicks off in the second week of July. Companies in the S&P 500 are expected to report a 7.2% decline in earnings for the second quarter, marking what would be the third consecutive year-over-year earnings decline.
Investors are on the lookout for whether corporate pricing power is ebbing. The net profit margin of companies in the S&P 500 is expected to fall to 11.4%, notably lower than the 13% peak reached in 2021. Companies might find themselves squeezed at both ends as they face rising financing costs while also struggling to raise prices further as inflation recedes. Revenues will be especially vulnerable to fickle consumer confidence levels. If earnings disappoint in a significant way, expensively priced markets will likely struggle.
2. The yield curve is deepening
Source: Federal Reserve of St Louis, WSJ
About a year ago, the US bond market began flashing a recession signal: yield curve inversion, when the yield on the 10 year US Treasury trades below the 2 year Treasury. Recently, the yield on the 10 year note traded more than 1% below that of the 2 year yield – the widest negative gap since 1981.
Investors look to the US Treasury yield curve as a gauge of economic health. The normal shape of the yield curve is gently rising from left to right, indicating higher yields available over longer periods. When the curve inverts, it tends to mean that bond traders are betting the Fed will keep rates high in the near term to fight inflation, possibly causing a recession – but will then need to cut them later to resuscitate the economy.
We’ll continue with key issues 3, 4 and 5 in tomorrow’s Quick Bite (i.e. part 2).
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