The stock market hasn’t looked so cheap in nearly two years

While major indices are still hovering near record levels, early-year selloffs in technology and other growth stocks have brought valuations closer to historical benchmarks. Stocks resumed their decline this week, with the S&P 500 down 3.7% on Thursday and Friday after a hotter-than-expected inflation report bolstered the case for tighter monetary policy from the Federal Reserve.

According to FactSet, the US stock benchmark traded at a low of 19.3 times projected earnings over the next 12 months at the end of last month, falling below 20 for the first time since April 2020. It was below the 21.5 multiple at which the benchmark entered. years but still above the five-year average of 18.9.

Concerns about how quickly the central bank will raise interest rates and how the economy will react have made investors cautious about calling down for a sell-off. Many expect that companies will need to deliver strong profit growth for stocks to start continuing advances.

“Now that we’re talking about higher interest rates, future earnings aren’t as solid or clear,” said Megan Hornman, chief investment officer at Verdance Capital Advisors. “That’s why people aren’t paying that high.”

The stock market seemed on the verge of gaining its footing just days before Thursday’s inflation report cut its momentum — and potentially put pressure on the Fed to raise interest rates faster than expected. Consumer-price data showed inflation rose to an annualized rate of 7.5% in January, a 40-year high.

The White House’s statement on Friday that Russia could invade Ukraine at any time has raised concerns in the market.

The S&P 500 lost 1.8% for the week, while the tech-heavy Nasdaq Composite lost 2.2%. The index is down 7.3% and 12% respectively this year.

High-end stocks like the technology sector have taken the worst pain recently, while investors have embraced cheaper stocks.

The top-performing S&P 500 sectors of the year are those that ended 2021 with the lowest price-to-earnings ratios. The energy sector traded at 11 times its estimated earnings on December 31 and is now up 26% year-on-year. The financials segment, which entered the year at 14.7x earnings, is the only other sector in positive territory for the year with 2.5% growth.

Stocks such as Exxon Mobil Corp. and Bank of America Corp. have outperformed the stocks of many growth companies that have propelled the market higher in recent years.

Exxon is up 31% this year, while Bank of America is up 7.7%. Facebook parent Meta Platform Inc is down 35% after disappointing investors last week with declining profits and a disappointing forecast. Tesla Inc. is down 19%, and Microsoft Corp. is down 12%.

Bond yields have jumped, with the yield on the benchmark 10-year US Treasury note reaching 2% on Thursday for the first time since 2019.

Rising yields weigh on stock valuations, especially in valuable sectors such as the tech sector, because they reduce the value investors put on companies’ future cash flows while making bond fixed payments more attractive. Stocks may still move but rely more on rising profits to justify their gains. High returns also help government bonds compete with corporate dividends to attract the attention of income-focused investors. The dividend yield of the S&P 500 is 1.29%.

Saira Malik, Chief Investment Officer, Nuveen, said, “While we are pleased to see that valuations have come down slightly, it is not the key driver we are counting on for the markets to rise higher.” “We’re counting on earnings.”

Analysts forecast profits for companies in the S&P 500 to rise 8.5% in 2022, FactSet data show, a slowdown from the 47% growth projected for 2021.

The stock became increasingly expensive in 2020 when share prices rallied ahead of earnings estimates. Broad monetary and fiscal stimulus to support the economy during the pandemic pushed investors into riskier assets and sent stock indexes hitting records. This was followed by a jump in corporate profits.

So far this year, the Russell 1000 Value Index has outperformed the Russell 1000 Growth Index by 9.5 percentage points. According to Dow Jones Markets data, this is the biggest gain in value stocks in any year since 1994.

The price index is down 2.5% for the year, while the growth index is down 12%.