Chief Investment Officer | Johnson Financial Group
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.
6 minute read time
The S&P 500 Index has traded at 2,900 several times in the last two years, and each time the environment was very different. Understanding those differences helps give insight into whether the “third time’s the charm,” with potential for additional advances beyond the 2,900 level.
But before taking a look three instances of the S&P at 2,900, let’s zoom out a bit. There are many things that frustrate stock investors. Among the most frustrating is the fact that a company’s stock price movement doesn’t always track its earnings success. We are fond of saying that stocks should really only trade four times a year, when companies report their earnings for the last quarter and provide future guidance. But of course, those earnings aren’t the only factors involved.
Rather, stock investors are, in effect, determining each day the present value of a company’s future earnings…in a context that’s much larger than the company itself. That means taking into account how the economy is doing, what’s happening with investor sentiment, how competitors are faring and other factors. The interplay of all these factors is why stock prices don’t move in a straight line in response to earnings.
In fact, even if a company’s earnings are strong, it’s possible to see its stock revisit the same price even though years have gone by, as investors weigh the potential impact of future economic conditions. The same applies at the stock index level, since an index simply represents the movement of a basket of stocks.
So, the S&P 500 at the 2,900 level provides a particularly noteworthy example of how the same number on the index can actually represent very different conditions:
Let’s take a closer look at each.
In August 2018, the economy had been recovering from the manufacturing recession of 2015/2016 for over 18 months. (Remember, that was another time oil prices dropped by more than 70%.) In 2018, economic growth peaked at over 3% in the second quarter and then began a decline. We were worried about slowing growth in China and the Federal Reserve raising interest rates too fast. The S&P 500 Index peaked in September and then began a rapid decline, exacerbated by the beginning of the tariff war with China that led to another softening in the manufacturing sector. Eventually, the S&P 500 troughed at near 2,400.
However, the gloom didn’t last long. By April 2019, we had climbed our way back to 2,900.
Why? Investors realized that unemployment was below 4% and would likely remain so. The economy was still growing at more than 2% and hadn’t begun to feel the effects of higher interest rates. And corporate earnings were still growing at an accelerated rate with company operating margins above 10%.
The market continued to climb, although almost entirely on the back of technology giants—particularly Microsoft, Apple, Facebook and Alphabet (Google). Together with Netflix, these stocks grew to represent more than 20% of the S&P 500 Index. Much of the rest of the market, however, had not returned to the highs made more than a year earlier, when the S&P 500 Index almost but did not quite reach the 2,900 level in January 2018.
As we entered 2020, these tech companies’ earnings and revenue were growing and they continued to be bid up. However, lurking in China was a pandemic that we now know well. The S&P 500 peaked near 3,400 in February and then very quickly saw the 2,900 mark again, this time on the way down, as stock prices went into free fall during March. Those thoughts of better corporate earnings and a tamer interest rate environment all but disappeared as the U.S. and global economy were shut down to slow the spread of the Coronavirus.
On March 23, the S&P 500 Index bottomed near 2,200, well below the sell-off level we had seen in late 2018. And why not, as there was a tremendous amount of uncertainty about companies’ future revenue and earnings growth. Fear took over, and investors began to sell stocks indiscriminately.
However, the federal government and the Federal Reserve, having learned many lessons from the 2008-09 financial crisis, acted very quickly. Whereas a complete recovery plan took more than 12 months to come together during the financial crisis, this time we saw the government passed four bills worth over $2.3 trillion in under four weeks.
In addition, the Fed provided a backstop to credit and money markets to ensure that they would begin running smoothly again. During the worst week in March, bond markets were not working. New bond issues couldn’t come to market and tens of billions of dollars were leaving the market. Companies that rely on the market to borrow needed capital couldn’t access the market. The Fed’s quick action provided respite in less than two weeks.
As a result of these actions, stock investors have bid up prices again and we’ve seen the S&P 500 Index move back through 2,900 this week. For us, this is a clear indication of how positively investors are viewing the federal government and Fed’s actions. We believe, though, that there may be too much enthusiasm in the stock market. After all, company earnings are what matter most to stock prices over time.
We are in the middle of the earnings reporting season for companies that make up the S&P 500. More than 170 companies have reported earnings so far. Earnings are down almost 20% even though most companies didn’t feel the effects of the shut down until the latter half of March. In addition, margins have slipped below 10%, and companies aren’t providing forward-looking guidance because it is hard to know what the future holds.
The market’s sectors will see an uneven recovery. The health care, technology, consumer services and communications sectors will likely recover quickly. Financials and materials will be battered, however, appear to be in reasonably good shape although recovery will take longer. Finally, industrials (which includes airlines and transportation) may take the longest to recover. And energy, given the decline in prices and decimation in demand will be on a very slow path to getting better.
So, this “third time” is likely not yet the charm. In fact, we may see 2,900 on the S&P 500 Index many more times in the coming months, on the way up and down.
However, what we do know is this: the economy will recover. The government’s programs will make a difference to how quickly the recovery takes place. The consumer remains over 70% of our economy and, as a result, targeting programs in that direction makes sense. Eventually, company earnings will recover. Over time, stock prices will move higher, just not in that straight line we’d all like to see.
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