As interest rates rise and inflation shows signs of calming, where are stocks in the market cycle?According to Peter Oppenheimer, our chief global stock market strategist, stock markets typically have four There are two phases, and the stock price is currently in the “optimistic” stage. He expects future returns to be relatively low due to the stock's wide trading range.
According to Goldman Sachs Research, most cycles begin with “despair” (a bear market), followed by “hope”, the strongest and shortest phase, when markets and valuations rise in anticipation of a return to earnings growth. do. Then there is usually a “growth” phase, where profits recover and grow, but valuations retreat and profits are moderate. The final stage, which Oppenheimer describes as “optimism,” generally involves valuations rising even as interest rates rise.
“If you look at the history of the stock market, it tends to repeat business cycles, a pattern of expansions, contractions, recessions, and booms,” Oppenheimer said in an interview with Goldman Sachs Exchange. He spoke at “We're a little bit more into what we would call a late-cycle 'optimism' phase because valuations are starting to rise again, even though interest rates are probably rising.”
Although the market phase is easy to identify in hindsight, there are signs that this cycle is following a typical pattern.
According to Goldman Sachs Research, the despair phase at the beginning of the pandemic was shorter than usual (just about a month) but similar in size to an average cycle. The desired stage was in line with the average in terms of duration (9 months) and annualized return (over 60%). Growth periods, despite their name, are usually accompanied by a decline in revenue. This is because although EPS is rising, it is often already paid out during the desired period. This is also the case in the current economic cycle, which has been weaker than average due to the speed at which interest rates have risen. The optimistic phase that began in late 2022 is largely consistent with history, with rising valuations.
The pattern of returns is similar to the past, but while the index fluctuates over a wide trading range, particularly during periods of despair and hope, returns are relatively low, resulting in “fat and flat” results, our analysts say. I expected it. Their return is driven by an ongoing tug of war between interest rates and growth concerns, above-average valuations (particularly in the US), and slowing earnings growth despite a high likelihood of a soft landing. is expected to be restricted. The S&P 500, for example, is at about the same level as a year ago. Japan and Europe are a little high, but Asia is a little low. Overall, world stock indexes were largely unchanged.
“The idea of 'fat and flat' actually comes from the context of being part of a cycle where trading ranges are wider and average returns are lower,” Oppenheimer said on the podcast. “And that’s exactly what we saw last year.”
The stock market has been rising in recent weeks, leading to optimism that it could break out of its trading range, according to Goldman Sachs Research. Stock markets rose and volatility declined as the U.S. resolved its debt ceiling standoff and deposit flight from U.S. regional banks slowed. Lower commodity prices have reduced the risk of inflation becoming more entrenched. Meanwhile, investors have recently turned their attention to artificial intelligence, with renewed enthusiasm for growth.
Combined, the stock market is up despite increasing pedestrian gains in most regions, and even in the long-lived technology sector of the market, which may not be fully profitable (especially if In some cases, valuations are rising despite rising interest rates. To the future. These are all characteristics of a typical late-cycle optimism phase, according to Goldman Sachs Research.
“Stock market volatility has decreased, especially over the past few weeks,” Oppenheimer said. “And that reflects a sense that some of the worst tail risks are being mitigated.”
Markets are also pricing in a reduced likelihood of a U.S. recession, moving closer to the outlook of our nation's economists, who believe that recession risks have faded.
Another way to look at it, according to Goldman Sachs Research, is to compare global cyclical stocks (stocks that are sensitive to economic growth) and defensive stocks, and compare that index to the Global Purchasing Managers Index ( PMI). Despite PMI survey data showing signs of softening, the market appears to be pricing in stronger growth potential going forward.
Mr. Oppenheimer is not as optimistic about the stock market as one might think. He argues that further upside is constrained by already high valuations and the prospect that interest rates will remain high for longer than the market is pricing in. Comments from the European Central Bank have become more hawkish, with Federal Reserve Chairman Jerome Powell recently stressing the need for more monetary policy. Tighten. The Bank of England and Norway's Norges Bank surprised investors with larger-than-expected rate hikes. Meanwhile, the PMI continues to show signs of weakness, with the weakness extending from manufacturing to services.
Oppenheimer said on exchange that rising interest rates have been a major driver for bonds and stocks over the past year and a half. “We're nearing the end of that cycle. By the way, we don't think we're there yet, but we think interest rates need to rise a little bit more.”
Stock market valuations also appear to be becoming decoupled from real (inflation-adjusted) interest rates. Despite rising real bond yields, the S&P 500's price-to-earnings ratio has soared recently. This suggests investors are expecting rapid rate cuts, long-term growth expectations are rising, or a combination of both. Oppenheimer believes optimism is premature. Our economists argue that the inflation path suggested by the market remains too optimistic, and that the prospects for lower interest rates are too strong.
Even if markets are right that rates will be cut sooner than economists expect, the reason for the cut will still be important, Oppenheimer said. In recent market cycles, stock returns after interest rate cuts begin depend on economic growth and market valuations. At this point, unless a recession occurs, there is likely less urgency for central banks to cut interest rates than markets are pricing in. And while Goldman Sachs Research doesn't predict a recession, economists' growth outlook remains subdued. The combination of high valuations and relatively modest earnings growth suggests a positive, albeit modest, return for stocks, Oppenheimer wrote.
“Growth is really the core driver, and we've seen very little underlying earnings growth this year,” Oppenheimer said. “What's important…[are] The expectations are about whether a recession can be avoided and what kind of economic and profit recovery we will see over the next year or two. ”
Another concern is that a relatively small number of stocks are driving much of this year's returns. The 15 largest companies in the U.S. and Asia will be responsible for much of the performance in these markets in 2023, according to Goldman Sachs Research. European market spread is somewhat healthy, but median company performance is very modest. Year-to-date (through June 27), the top 15 companies in the S&P 500 Index have gained 34%, while the median company has gained just 1%. Based on this, Japan has made the most impressive gains, with the median value of companies increasing by 11%.
Will the rest of the market catch up with the soaring stocks, or will the market leaders come back to earth? In Europe, where the market is rising with a narrow leadership, according to our analysts, the following 12 The monthly composite index return is positive 71% of the time (the unconditional average after the rally is 62%). There have been signs that the breadth of the market has started to improve recently, suggesting that growing confidence in growth is leading to widespread optimism in the non-tech portion of the market. However, the narrow contribution to earnings remains noticeable, particularly in the United States, where tech stocks have been driving earnings.
Oppenheimer said tech companies have rebounded despite rising interest rates, suggesting investors are optimistic that AI can deliver higher long-term growth. There is. This is reflected in the fact that U.S. technology valuations are ahead of other markets, such as being pulled away from European technology sector valuations, he says. Oppenheimer said AI could benefit far more than just a handful of technology companies.
“As we've seen with the Internet, as these technologies develop, companies that probably don't even exist yet will be the big beneficiaries because they create new opportunities for new entrants,” he said. says. “There is an opportunity to really increase productivity across the economy. But in order to realize that, some of the big winners are actually going to be non-tech companies. Companies that are implementing AI in the U.S. Of course, not all of them are in the United States.”
At the same time, a comparison of US and European sectors with return on equity on a book value basis shows that most sectors are valued in line with expected profitability. The S&P 500 and Europe's STOXX 600 are trading in line with expected returns, with the possible exception of tech stocks.
“Over the medium term, we think investors can get good returns in stocks, but probably not the returns we've seen over the past 10 to 20 years,” Oppenheimer said. .
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