The stock market has seen a broad rally this week and one that includes far more companies than just Big Tech. While investors would certainly love to close out the year on a high note, several hurdles remain.
The
Invesco S&P 500 Equal Weight
exchange-traded fund has surged 17% since late October, when it hit its lowest level since October 2022. This ETF weighs each stock in the index equally and serves as a truer gauge of the average stock’s performance for the
S&P 500.
The main driver of the gains has been the decelerating pace of inflation, which has led the Federal Reserve to refrain from further interest-rate hikes over its past two meetings. The central bank signaled this week that it might even cut interest rates in 2024. That would enable the economy to continue growing and keep companies’ sales and profits on the rise. Lower rates also make future profits and dividends more valuable, lifting valuations for all sorts of companies from high-dividend payers to high-growth technology firms.
The good news is the market does have a solid shot at sustaining its rally from here. Not only did stocks burst higher Wednesday after Fed chair Jerome Powell spoke, but they closed in the green Thursday afternoon too, even without much additional news on rates and the economy. That “follow through” for stocks indicates that traders and investors alike are happy to keep buying, as they bet that profits will take share prices higher going forward in the long-term.
This “upside follow through” is key for more gains, wrote Cappthesis’ Frank Cappelleri, who sees more gains ahead for the standard, market value-weighted S&P 500.
Now for the bad news. When it comes to stock investing, nothing is guaranteed, and neither are explosive market gains from here. A few factors increase the risk of a market decline in the near-term.
First, stocks are now reflecting almost as much optimism as they can, making equities vulnerable to any disappointments. The equal-weighted S&P 500 is trading at 16 times expected per-share earnings for the coming 12 months, rising from just below 14 times at the start of the October rally. While that is lower than the standard index’s 19.4 times, it certainly isn’t cheap. Plus, the equal-weighted index has hardly ever traded above the standard one in the past decade, according to FactSet.
That means, if financial results don’t pan out to expectations, stocks could easily fall. Today, analysts expect aggregate sales on the equal-weighted index to grow 3.8% in 2024. They forecast higher profit margins, as the rise in employee pay and product costs moderates. More stock buybacks would also push per-share earnings higher, with the consensus forecast calling for 8% bottom-line growth in 2024. But those profit projections are dependent on continued economic growth.
“We struggle to embrace the consensus logic calling for 12% profit growth,” wrote Comerica Wealth Management’s chief investment office, John Lynch, who sees a market drop as likely.
And if earnings-related disappointments don’t ruin the stock market’s party, the Fed still could. While markets now anticipate interest-rate cuts next year, the rate of inflation—3.1% on an annual basis in November—is still above the Fed’s 2% target. If consumer prices increases don’t moderate quickly enough, investors could lower their expectations for the number of rate cuts. That likely would cause many stocks to reverse some of their recent gains.
“Investors should be wary of the pace and timing of cuts, so they don’t get ahead of themselves,” wrote Charlie Ripley, senior investment strategist for Allianz Investment Management.
So while this week’s rally and changing rate outlooks give investors plenty to celebrate this time of year, don’t gorge on stocks right now—save that for any holiday dinners ahead.
Write to Jacob Sonenshine at [email protected]
Read the full article here