What Wall Street pros are saying about the stock market rout 🤕

Some good 📈, some bad 📉, some ugly 🥴

May 2, 2022

2022 has been a rough year in the stock market.

That might seem like an understatement. But believe it or not, the 15.7% drawdown the S&P 500 has experienced from its January all-time high to its intraday low on Monday is not far from the average move in an average year. Indeed, encountering short-term volatility on the path to long-term gains is what investing in the stock market is all about.

Below, I round up some of what Wall Street’s top strategists are flagging to their clients1 amid the stock market rout. Many of you will recognize that much of what’s being said is in line with the long-term themes we continually discuss here at TKer.

The stock market has hit a rough patch.

Below, I round up some of what Wall Street’s top strategists are flagging to their clients

amid the stock market rout. Many of you will recognize that much of what’s being said is in line with the long-term themes we continually discuss here at TKer.

In summary: The good news is earnings are holding up. The bad news is there are lots of factors to be worried about, including rising interest rates. The ugly truth is that volatility is always a thing when you’re invested in the stock market, and this year’s moves are nothing out of the ordinary.

Good: Earnings are doing better than expected 📈

Quarterly earnings announcements have been beating analysts expectations, which TKer subscribers know is in line with history.

“For Q1 2022 (with 55% of S&P 500 companies reporting actual results), 80% of S&P 500 companies have reported a positive EPS surprise and 72% of S&P 500 companies have reported a positive revenue surprise,” John Butters, senior earnings analyst at FactSet, wrote on Friday.

Most companies are beating expectations.

The margin by which S&P 500 companies in aggregate are beating expectations is below the historical average of 4.9%, said Binky Chadha, chief strategist at Deutsche Bank. He cautions, however, that the aggregate averages are a bit skewed by disappointing results from a handful of unusually large companies like Amazon.

“Indeed, the median beat across companies, which is not impacted by outliers, is a very solid 6.2%,” he said.

Analysts attribute much of the resilience in corporate earnings to profit margins holding up.

“Despite concerns about cost pressures, margins remain close to the records set last year,” Chadha said. TKer subscribers know that warnings of collapsing profit margins amid inflation has been the biggest corporate red herring of the past year.

“Through Friday, aggregate 1Q22 operating margin for the 221 non-S&P Financials that have reported was up ~30bps vs. 4Q21,” Christopher Harvey, senior equity analyst at Wells Fargo Securities, wrote on Monday. “This is despite a 3% sequential decline in total revenues.“

Perhaps the most bullish developing story has been the upward revisions to analysts’ expectations for earnings throughout 2022. As TKer subscribers know, earnings are the most important driver of stock prices in the long run, and analysts seem to only be revising these numbers up.

“Since the beginning of earnings season, 2022 EPS has been revised up 0.8% to $228.95 (+10% y/y),” Dubravko Lakos-Bujas, head of U.S. equity strategy at JPMorgan, observed on Monday. “Looking to the following year, 2023 EPS has been revised up 0.4% since the beginning of the earnings season to $251.19 (+10% y/y).”

Bad: Uncertainty is high, and we don’t know how bad it could get 📉

There’s always something to worry about when it comes to investing. That’s just the price stock market investors pay for the outsized returns they earn.

But sometimes, markets will reflect an unusually elevated level of uncertainty when risks emerge out of nowhere, when it’s unclear how bad the worst-case scenario for a certain risk can get, and when it’s unknown how long a challenge will last.

In a note to clients last week, DataTrek Research co-founder Nicholas Colas succinctly summed up the major uncertainties driving markets haywire right now:

“The overarching problem with US/global equities just now is that the market’s two largest overhangs – Russia-Ukraine and future Federal Reserve monetary policy – have no clear solution or even a timetable for a resolution. Being out of equities entirely risks missing a relief rally. Sticking around means hoping for the best. A good long-term strategy, but painful just now.”

None of the strategists followed by TKer are suggesting to get out of stocks outright. But many have either cut their price targets for stocks and/or suggested trimming exposure to stocks.

On Friday, BofA cut their 2022 year-end target on the S&P 500 to 4,500 from 4,600. They joined Goldman Sachs, JPMorgan, UBS, RBC, and Barclays, who all slashed their targets in recent weeks.

“What's changed since January 1?” wrote BofA’s Savita Subramanian. “We weren't forecasting a war, and the Russia/Ukraine conflict exacerbated commodity price inflation and also hit Europe GDP hard. The Fed (and other central banks) have shifted to a far more hawkish stance. China growth is worsening and other cyclical indicators have rolled over. This is all against a backdrop of cyclically peaked S&P 500 EPS facing secular margin pressure (de-globalization), still lofty valuations and a Fed taper still in play.”

On lofty valuations and hawkish monetary policy, many experts will tell you that high valuations and rising interest rates is a bad combination for stocks. Indeed, billionaire investor Warren Buffett once said, “Everything in valuation gets back to interest rates.“

Rising interest rates would explain why stock prices have fallen despite expectations for continued earnings growth. This narrative is illustrated in the chart below from Credit Suisse. It shows the S&P 500 falling with the next 12-month P/E multiple, which is perhaps the most popular way of measuring stock market value.

“The textbook view of valuation says that higher rates should lead to lower valuations,” Michael Wilson, chief U.S. equity strategist at Morgan Stanley, wrote on Monday. “Today this story is painfully unfolding with the highest inflation in 40 years and rates nearly doubling over the past two months, yet index valuations remain stuck at historically high levels.”

Colas cautions against getting too comfortable with those forward earnings estimates. He believes falling valuations mean the market is betting that those expectations for earnings growth will be revised down.

“Valuations rise when markets think earnings expectations are too low and fall when they're too high and unachievable,” Colas wrote.

Ugly: This volatility is normal in investing 📈📉🤮

Buffett might argue that rising interest rates may help explain why markets are moving the way they are. But the last thing he’d do is suggest that you use this information to try to time the market.

That’s because it’s just not possible to know what the market may do in the short run.

In fact, Buffett revealed on Sunday that his firm, Berkshire Hathaway, aggressively bought $51 billion worth of stocks in the first quarter, during a period when many would argue short-term prospects for the market were deteriorating. For Buffett, it doesn’t matter if prices go down further in the short term as long as he has conviction that these investments will pay off in the long-term.

“Over the next 20 years, I would expect to have more capital gains than not,” Buffett said. Indeed, since 1926, there’s never been a 20-year stretch during which the stock market didn’t generate a positive return.

Buffett was an aggressive buyer of stocks in the fall of 2008 during the financial crisis. The stock market went on to tumble another 26% before bottoming six months later. At the time, the trades looked “dumb.” But after a few years, they were very much in the money.

John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, reflected on the market during the financial crisis.

“Work-out markets from crisis are never easy with negative and positive outcomes from actions taken along the way obfuscating what progress has been made and roiling investment sentiment along with stock and bond prices,” Stoltzfus wrote on Monday. “Two steps forward three backward is not uncommon as markets ‘navigate their way out of the woods’ looking to find toeholds to climb a wall of worry.”

This year has come with the S&P 500 setting a record high of 4,818 on January 4, then falling to 4,114 on February 24, then rallying 4,637 on March 29, and then tumbling to 4,062 at one point on Monday.

This 📈📉📈📉 pattern isn’t actually that unusual.

“While the slide has certainly been painful, it is important to note that market retests of correction lows are quite common, and do not necessarily indicate that US stocks are headed for a longer and more severe drawdown,” Brian Belski, chief investment strategist at BMO Capital Markets, wrote on Wednesday.

He included this chart that mapped the average trajectory of corrections (i.e., when the S&P 500 falls by more than 10%) that don’t enter a bear market (i.e., when the S&P 500 falls by more than 20%).

The bottom line

Resilient earnings are at odds with worries about the future. Unfortunately, we’ll only know how bad things will get in hindsight.

In the meantime, stocks are down and there’s nothing pleasant about that. But as TKer readers know, investing can be unpleasant. It’s the risk that makes for higher returns.

As Colas said: “Being out of equities entirely risks missing a relief rally. Sticking around means hoping for the best. A good long-term strategy, but painful just now.“

More from TKer:

The views among Wall Street’s equity strategists are nuanced and can vary significantly. Each one argues their views by spotlighting the evidence that supports their bullish or bearish conclusions while also acknowledging the data that may suggest otherwise. I’m only able to pull excerpts. If you’re interested in getting their full reports, you’ll have to request it from them directly or become a client.

TKer by Sam Ro