This year has been a tough one for investors. Both the stock and bond markets have endured sharp losses and high volatility. There’s on-again, off-again talk of recession, the Fed continues to aggressively raise interest rates, and inflation notched its highest readings in four decades.
The good news is many of these sources of market anxiety could be on the mend. Is the path all clear for a new bull market? Of course not. But much of the bear market could already be in the rearview mirror.
Look at it this way: Would you rather be investing now or a year ago? In November 2021, crypto mania was in full swing, stocks were near their all-time highs, and interest rates were near the lowest seen in modern history. Inflation, while on the rise, was not a big concern. Many Wall Street investment bank forecasters didn’t even expect a significant rate hike cycle in 2022.
Investors’ prospects today are much better after this difficult stretch. Here are five reasons to be optimistic — and even thankful — as we head toward the end of the year.
1. Lower stock valuations
The S&P 500 is priced at about 17 times next year’s earnings estimates, according to FactSet — by no means an extremely attractive buy relative to history. The 10-year average earnings multiple is 17.1, and that covers a timeframe in which interest rates were much lower.
The upshot is that domestic large-cap equities are well below their forward price-to-earnings (P/E) range in the low 20s from mid-2020 through early 2022. Moreover, valuations outside of mega-cap tech stocks are reasonable with a forward P/E near 16. Small caps and foreign shares may be downright bargains as well.
2. Higher bond yields
Investors can get caught up in the excitement of the stock market, but now’s a time to give the bond market a look. Consider that investment-grade corporate fixed income yields more than 5.5%. The rate was above 6% just a couple of weeks ago — the highest since 2009.
You could also earn more than 4% guaranteed by the U.S. government in short-term Treasuries. Finally, volatile parts of the bond market, such as U.S. speculative-grade fixed income and emerging market debt, feature yields in the high single digits.
3. Bullish seasonal tailwinds
We’ve talked about how the midterm elections often spark a significant rally on Wall Street. That might already be underway with the S&P 500 up more than 13% from the low a month ago. Certainty around a divided government next year helps relieve jitters around changes in laws and policies — always a good thing, so we can get down to business analyzing financial markets. The S&P 500 historically rises 15.1% in the six months post-midterms.
4. A decent job market for most workers
Here’s where we need to temper expectations. Jobs are plentiful right now, but wage gains after taking inflation into account are not good — in fact, they’re negative and have been for a whopping 19 months in a row.
Also, some strategists forecast job losses during the middle of 2023. So far, layoff announcements have been concentrated within tech. And for context, while the Information Technology sector is 26% of the S&P 500 by market cap, the group represents a small percentage of the overall labor market.
The rest of the employment picture looks decent. In fact, according to the Atlanta Fed Wage Tracker, earnings are up more than 7% for the lowest quartile of workers as of October. Tough times in Silicon Valley could set up a possible mild tech-led recession while blue-collar workers and other industries should fare better.
5. Falling inflation
We have concerns about the labor market, but there are clear signs inflation has peaked and could even become a footnote by year-end 2023. The year-over-year percentage rise in Consumer Price Index (CPI) has dropped from 9.1% this past June and now stands at 7.7%.
Still high? Yes. But earlier this month, the October inflation reading was better than what economists were calling for, and that sparked the biggest single session climb for the S&P 500 since April 2020. Finally, traders currently expect tame inflation of just 2.3% annually over the next five years. Of course, we must acknowledge the risk of more geopolitical turmoil leading to higher commodity prices.
The bottom line
The future is never certain, but there are reasons investors can feel good about what lies ahead. Conditions appear more favorable for better returns over the coming year after a difficult 2022.