HIGHLIGHTS:
- Volatility continued throughout the second quarter, with most major stock markets declining in the low to mid-teens.
- Large US stocks are now valued below their 5-year and 10-year averages as share prices fall and earnings expectations remain optimistic.
- Wall Street analysts predict lower earnings growth in the second quarter, mostly due to a tough comparison versus a stellar quarter last year.
- Earnings are projected to grow by 10.4 percent in 2022, and next 12-month expectations are over 34 percent higher than the pre-pandemic peak.
Financial markets continued their slump during the second quarter. Investor sentiment remained gloomy in the shadow of an aggressively tightening Federal Reserve, persistently high inflation, and fresh worries over slowing economic growth. With only another day or two to go, the S&P 500 Index has lost about 15 percent after finding a foothold and regaining some ground in the last few weeks of the quarter. Similarly, most other major stock markets declined by low- to mid-teen levels, with the exception of emerging markets, which had already gone through a rout of its own throughout last year. The selloff in stocks has created a compelling value proposition. The S&P 500's price-earnings ratio—a common valuation metric for stocks—has fallen from over 21 at the market peak in late 2021 to about 16 currently. That decline is larger than the S&P 500's actual price drop; it also reflects a valuation below the 5-year average of 18.6 and the 10-year average of 16.9. All that is to say, stocks are looking cheap.
Part of the reason for the larger valuation decline involves earnings expectations. After earnings grew by about 9 percent in the first quarter, analysts are forecasting a little more turbulence for corporate profits. Wall Street analysts are reducing their second-quarter forecasts to around 4 percent due to an abnormally stellar second quarter of 2021 and as questions arise over how companies and consumers will fare amid higher prices and rising rates. However, it seems analysts' uncertainty will be short-lived, with projections for 10 percent earnings growth in both the third and fourth quarters of 2022. Predictions for full-year earnings growth for the S&P 500 continue to hover around 10.4 percent. While companies have weathered inflation relatively well by cutting their own costs or passing them to consumers, it remains to be seen whether they'll reach that target. However, Wall Street analysts are so optimistic about earnings over the next 12 months that their predictions are over 34 percent higher than the pre-pandemic peak.
Right now, the main issue for investors is monetary policy. Fed Chair Jerome Powell has reiterated that the US economy is in strong shape and can avert a recession amid his campaign for higher rates to subdue inflation. Investors are unsure if that's true, and it's caused substantial volatility in the past few months. While this has created an issue now, earnings expectations still reflect confidence and support for stock markets in the near term.
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