BY: RYAN P. JOHNSON, CFA, CFP® - MANAGING DIRECTOR OF INVESTMENTS
Inflation continues to moderate, the services portion of the economy continues to grow, and jobs are strong. The debt ceiling debate could throw a (short-term) wrench into this year’s positive momentum, while the Fed’s next move is still uncertain.
We expect the debt ceiling to be raised and the issue to be deferred, as usual, though this may be a closer call than we’ve seen in many years. At the time this was written, a two-year deal seemed close, but not guaranteed. In the case of a default, many negative consequences would likely ensue, but we expect the majority of the issues to be temporary. It is likely that Treasury yields would increase across the board, unemployment would increase, and stocks would fall, though we would expect these issues to be short-lived. All government debts/interest/wages would eventually be paid, likely within a very short period of time. If a default occurs, even if an agreement is made quickly thereafter, we would not expect everything to bounce right back to where it was before: bond yields may stay higher and stock prices may stay lower for a while before normalizing.
Although the next Fed interest rate decision is right around the corner on June 14th, the next move, or pause, is uncertain. The latest reading on the Fed’s preferred measure of consumer inflation, core PCE, was 4.7%, slightly higher than 4.6% from the prior month. Most other inflation readings, especially for producer prices, have continued to decelerate. Some Fed members are still calling for additional hikes to ensure inflation is stamped out, while others would like to pause (our preference) and see how the effects of their rapid rate hike campaign play out.
In mid-May, the S&P 500 hit its highest level since last August, while the Nasdaq 100 hit a new 1-year high. Nine very large stocks account for all of the year-to-date gain in the S&P 500: Apple, Microsoft, NVIDIA, Alphabet, Amazon, Meta, Tesla, Salesforce, and AMD. This Tech-heavy outperformance has led the growth style to outperform value this year, opposite of what occurred in 2022. Earnings results from Q1 were better than expected, though in aggregate earnings declined from Q1 a year ago. Q2 earnings are also expected to be lower than a year ago, but year-over-year growth is expected in the second half of the year.
Since our last Insights, we have posted two videos: Limitations of Using an AI Chatbot and Social Security Solvency and Filing Strategies that can also be found at www.mybuckingham.com under Resources – Video Library.
Some stocks have high share prices, while others are low – why?
A stock’s share price is based on the total market value of the company divided by the number of shares outstanding. All companies have a different number of shares, and this can be changed with a stock split, new shares being issued for an acquisition, or shares being taken away from the market via buybacks. Years ago, it was popular to have a share price that was attractive to retail investors – often below $50. Now, to signal strength, a company may manage its share count to have a share price over $100. Stocks with share prices under $5 are considered speculative.
How is a stock’s valuation related to investor confidence?
A stock’s value is more than its share price. Its valuation is the price divided by a profit metric like earnings per share. Price divided by earnings is also known as the P/E ratio. Using a P/E ratio, for example, allows us to compare the relative value of different stocks, even though they have different prices, share counts, and earnings. The more stable or predictable a business is, all else equal, usually leads investors to pay a higher P/E multiple. The more cyclical or variable a business is, all else equal, the lower the P/E multiple will be paid for that business because investor confidence is lower about what the results might be from year to year. One example would be the higher value placed on each dollar of profit from Consumer Staples stocks (think Procter & Gamble or Pepsi) than Airline stocks. One group is “all-weather” while the other may be weather dependent. From these norms, we then evaluate whether a stock is relatively attractive or expensive at a sector level.
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Ryan P. Johnson, CFA, CFP®
Managing Director of Investments
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.