Wells Fargo equity analyst Christopher Harvey detailed both the bull and bear case for global markets while also adding an effective rule of thumb for assessing the attractiveness of U.S. stock valuations.
The bull case for equities is basically that the bad things that are happening stop happening. The prime hope is that U.S. employment data soften and a Fed pivot – the end of U.S. rate increases – becomes possible. Geopolitically, a resolution in the Ukraine would be extremely bullish for stocks.
Negative earnings revisions by corporate executive have been an unhelpful trend for markets in recent weeks. So far in S&P 500 earnings season, however, results have been less weak than feared. With 99 companies having reported, earnings have exceeded consensus estimates by 4.5 per cent. Mr. Harvey believes that non-disastrous earnings reports could steadily reduce investor anxiety and result in sizeable rallies.
Domestically, there are also concerns about profit growth. In a Friday research report, Scotiabank strategist Hugo Ste-Marie warned investors to “prepare for the worst” ahead of TSX earnings reporting. The strategist expects third-quarter earnings to come in 4.2 per cent lower than the second quarter. Here too, if actual earnings are not as bad as feared, this would result in equity buying.
The bear case for equities features more central bank rate hikes, significantly slower economic and profit growth, and a steep market sell-off. Operating profit margins, hit by higher input costs thanks to inflation, begin to erode and limit earnings growth.
The potential for financial instability emanating from the U.K. is also a possibility. The nation’s political upheaval combined with relatively precarious fiscal position may result in a disorderly weak U.K. bond market and cause global stock weakness.
The “good news is bad news” pattern may also affect equities negatively. Strengthening economic data could embolden central banks to tighten monetary conditions even more quickly.
Interestingly, Mr. Harvey calculates the fair value price-to-earnings (PE) ratio for the S&P 500 as the reciprocal of the discount rate. Currently, the risk-free rate plus a risk component puts the discount rate at 6.15 per cent. The reciprocal of this, 16.3, is the warranted PE ratio for the S&P 500.
This PE ratio, multiplied by consensus earnings estimates for the next 12 months, means the S&P 500 should be at 3720, only marginally above current levels. The fact that U.S. equities appear roughly fairly valued by Wells Fargo’s standards helps explain why Mr. Harvey is neither bullish or bearish, merely watching to see which scenario plays out from here.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
PHX Energy Services Corp. (PHX-T) In recent days, the share price has been rising on high volume. Quarter-to-date, the share price is up over 21 per cent and year-to-date the share price has rallied nearly 58 per cent. Jennifer Dowty takes a look at the Calgary-based company.
The Rundown
Further market turbulence appears inevitable as Canadian earnings season commences
Investors are bracing for a rocky earnings season to roll out in Canada in the weeks ahead as companies continue to absorb the impacts of higher inflation and borrowing costs that have consumer watching their wallets. Brenda Bouw previews an important stretch for equity markets.
The worst bond market ever?
Few investors need reminding that stocks are having a rotten year. But the slump in equities is a mere tremor compared with the tectonic shifts underway in the bond market. Tim Shufelt explains.
See also: As U.S. Treasuries tumble, some investors say turning point is near
Buy low? Forget it - investors today are buying safety
It’s a bargain hunter’s wonderland in investing right now. Stocks are down by double-digit amounts for the year to date, and so are bonds. There’s so much to choose from for the long-term investor willing to gauge success by what happens in the next five to 10 years. Rob Carrick looks at the options available.
Halloween, the dollarization of terror, unsafe havens and stocks
Boo! Halloween approaches fast. And markets look comparably ghostly and ghastly. Both world stocks, bogged in a bear market, and the TSX flounder near summertime lows. Consensus opinions fear worse. “Capitulation” – that cascading panic-selling common as bear markets end – hasn’t come. But two dastardly demons make that ending unlikely, writes Ken Fisher.
U.S. banks stocks have become a favourite for investors betting on a rebound
As investors and strategists contemplate whether the bear market in stocks is close to bottoming out, beaten-up bank stocks appear to be emerging as an early favourite, according to David Berman.
Others (for subscribers)
The highest-yielding stocks on the TSX, plus risk data
Friday’s analyst upgrades and downgrades
Thursday’s analyst upgrades and downgrades
Number cruncher: Ten U.S.-listed tech stocks with solid earnings growth in beaten-down sector
Short sales on the TSX: What bearish investors are betting against
Others (for everyone)
Sterling may decide if BoE can talk markets off a cliff
Canada’s No. 2 pension fund Caisse sees opportunities in battered bond market
Truss defied the markets, and they ruthlessly sealed her fate
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Question: I have a TFSA with EQ Bank, currently invested in cash. I am considering the purchase of a one-year GIC at 4.5 per cent. On its maturity I plan to close the EQ TFSA and transfer the full amount to an already exiting TFSA with TD Waterhouse. Are there any problems with this course of action?
Answer: No problem, as long as you go about it the right way. Don’t simply withdraw the money from EQ and redeposit it in your TD account. The Canada Revenue Agency would see that as a new contribution and that could subject you to overcontribution penalties.
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-- Gordon Pape
What’s up in the days ahead
Westminster woes, Tokyo on yen watch and other world market themes for the week ahead
GM, Ford set to report earnings to a tough crowd on Wall Street
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Compiled by Globe Investor Staff