S&P500 getting into a party mood?

Feel free to reach out to PSG Wealth Manager Schalk Louw directly.

At the beginning of this year (2023), investors approached stock reviews for the upcoming year with great scepticism, given that the S&P500 Index had experienced an 18% loss in value in the previous year (2022). Initially, the outlook seemed to confirm their concerns, as the S&P showed no signs of recovering from the declines of 2022 by mid-March. However, the situation quickly turned around, and as at 19 May 2023, the same index is now trading 10% higher in US dollar terms for the year to date. It is evident that the market performance has surpassed the expectations set by forecasts for this year.

Shares tend to respond positively when earnings growth exceeds expectations, while they react negatively when reported results fall short of expectations. In times of extreme negativity, investor sentiment can be so greatly influenced that it may lead to a complete collapse, as observed in 2008, 2020, and 2022.

It is worth noting that even if a company's results improve compared to the previous reporting period, the share price can still experience a significant drop if it fails to meet expectations. Conversely, share prices can rise despite a decline in profits if investors expected the decline to be even more severe. Therefore, consensus forecasts play a crucial role in short-term market volatility.

In several of my previous reports, I have emphasised that these experts are not fortune tellers. While some analysts have remarkably accurate forecasts, there are always a few who miss the mark by a wide margin. Several reasons contribute to analysts making erroneous forecasts:

• Making earnings forecasts is incredibly challenging due to the numerous variables involved, making it difficult to anticipate unexpected factors.
• Over time, analysts' forecasts tend to converge, but blindly following the herd does not guarantee accuracy.
• Over-optimism can skew forecasts.
• Companies often employ strategic methods, such as well-planned press conferences and meetings, to soften the impact of bad news.

Graph 2: S&P500 Index expected 12-month growth (source: PSG Wealth Old Oak & Refinitiv)

Based on the same Refinitiv consensus target prices forecasts, analysts anticipate the party to continue with a projected 11.6% growth (excluding dividends) for the S&P500 Index over the next 12 months (from 19 May 2023). If their predictions were to materialise with 100% accuracy, it would result in a price earnings ratio of 18.3 times, which cannot be regarded as cheap, though not necessarily expensive either. 

Graph 2: S&P500 Index Forward PE ratio (source: PSG Wealth Old Oak & Refinitiv)

It can be likened to a cricket match where the Proteas are chasing a formidable score, requiring Temba Bavuma to hit the middle of the bat consistently.

In conclusion, I want to emphasise that one should not miss out on a party simply because you fear you will not enjoy it. If we consider the recent messages from the Fed and Fed Fund Rate futures, we might be approaching the end of the interest rate cycle, which could prolong the current positive market conditions. However, this party will continue as long as expectations are met.