It is becoming difficult for investors to assess the valuations of US stocks because of rising oil prices, volatile bond yields and an aggressive Federal Reserve that is determined to stave off the worst inflation the country has seen in four decades. Nonetheless, it cannot be denied that there are potential bargains to be made when the market is tumbling as it is now.
Stocks Have Come Down
There is absolutely no doubt that stocks have come down significantly since the start of the year. The S&P 500 index entered a bear market this week, as it has recorded a decline of 23% since the beginning of the year.
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While the value has come down, it is difficult to figure out if the stocks are cheap enough. Metrics have become quite clouded because of a macroeconomic landscape that is changing rapidly and volatility in the market. Therefore, investors cannot rely on Treasury yields and corporate earnings to value stocks, due to which potential buyers are not dipping their toes in.
Market strategists said that it would not be easy to figure out the fair value of equities until the earnings outlook and rates outlook become better visible. Most experts are recommending that people reduce their equity risk and invest in fixed income for the time being.
Pressure High in This Week
This week saw the stock markets come under more pressure, as the S&P 500 declined to its lowest after late 2020. This was after the US Federal Reserve implemented the largest rate hike seen since 1994. The forward price-to-earnings ratio of the index also came down this year, which is aimed at comparing the price expected with the profits expected.
At the start of the year, it had been about 21.7, but it had come down to 17.3, which brought it close to the market average of 15.5. Estimates had previously shown that there would be a 10% increase in the S&P 500 in this year. However, now market participants have become doubtful about whether these estimates will be able to hold up, considering the tightening financial conditions and surging inflation.
Earnings to Slow
Forecasts show that while earnings will remain positive this year, they will slow down. Moreover, a contraction is expected in the next year because a recession has now become a possibility for late 2022 and early 2023.
Analysts said that investors should bear in mind that the earnings and economy would become challenging, due to which they shouldn’t be fooled by the existing expectations. The Treasury yields are also an important factor to consider in this situation. As US debt is often regarded as an investment without risks, rising yields tend to drive people out of stocks.
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However, the problem is that yields have become highly volatile these days because of changing expectations of exactly how hawkish the US Fed is going to get. Therefore, this calculation has also become difficult for investors of late and market volatility continues to create uncertainty.