2022 Market Outlook

May 1, 2022

Buying Stocks On This "Dip"
Is Not For The Faint Of Heart

John Bonnanzio

I’ve been writing about Wall Street since Ronald Reagan moved into the White House (1981). Since that time, the world has yet to change in ways that are as physically apparent as when the car replaced the horse, or the light bulb supplanted oil lamps. On the other hand, the transition from the Industrial Age to the Digital Age has profoundly enhanced our understanding of everything, while also altering how we work, play, live and even invest. As my 94-year-old father (who has never owned a cellphone) likes to say, "sometimes I hardly recognize the place!"

The More Things Change ...

But even with so much change, there are constants — including when it comes to human behavior and investors’ inevitable waxing and waning between fear and greed. That’s not to say that all investment decisions are irrational, or are driven only by emotion.

That the Nasdaq Composite is down 21% this year on the heels of a prior 3-year average annual return of 24% only makes sense if corporate earnings roughly doubled during the same period, or if you believe that earnings growth would be accelerating. With that in mind, one charting company pegged the Nasdaq’s trailing price-earnings ratio at 29.7 at the start of the year. As of April 29 (with limited first-quarter earnings to measure), it has fallen to 22.6.

While some of that decline is the result of disappointing earnings (Amazon and Netflix were two high-profile examples), others have been "drive-by" victims of irrational selling: think Facebook’s parent Meta Platforms, Microsoft and Tesla. That said, earnings growth rates for online digital ad companies like Alphabet’s Google and YouTube are waning as competition for eyeball time intensifies against the backdrop of slowing economic growth and rising interest rates.

Bottom line: Increasing one’s large-cap growth/tech exposure amid the current "dip" may be opportunistic, though possibly premature.

Broader Market

On the other hand, there may be less risk (emphasis on less — I’m certainly not suggesting none!) in the broader market.

Although the S&P 500 is down a more benign 12.9% this year, its P/E is considerably cheaper in absolute terms (its trailing P/E is now 24.1 versus 39.8 a year ago) and relative to the Nasdaq. Moreover, its dividend yield (an important component of long-term total returns) is a healthy 1.46%.

Apart from valuations, there’s another reason for optimism.

While just over half of S&P 500 companies have reported, earnings aggregator Refinitiv says that over 80% of them have surpassed first-quarter expectations with profits rising 8.2% above last year’s level. (Forecasts called for an increase of 6.4%.)

While another earnings aggregator, FactSet, corroborates Refinitiv’s findings, it has so far found that among companies beating expectations, they’ve done so with earnings growth that has shrunk to single-digits. Of course, given the surging profit margins enjoyed by so many during the two-year pandemic, it’s inevitable that bottom- and top-line growth would slow.

Sector-wise, it should come as no surprise that energy companies blew the roof off earnings last quarter (up 256%!). Materials and industrials were big winners, too (though laggards relative to energy).

As for decliners, financials and consumer discretionary companies (which includes retailing, a sub-sector we’ve downgraded this month — see p. 5) are the only two of the 11 S&P sectors reporting year-over-year declines in earnings.

Action Recommendation

While cascading stock indexes are often embraced as sell signals, most of our readers have been with us long enough to know that the "time to get back in" signal never "flashes" until the big gains have already been booked. That said, with so many consequential unknowns at hand (China’s Omicron lockdowns and Russia, to name two), "staying the course" isn’t the sexiest of advice, but it’s the most sensible.

 — John Bonnanzio