Investors Beware: Stock Market Telling Us 2 Different Tales
The stock market is sending us two different messages at the moment. This isn’t the first time something like this has happened, but knowing what’s next could help investors make money, keep their profits, and limit their losses.
When it comes to forecasting where the stock market could go, investors and analysts use technical analysis (looking at share-price charts) and fundamental analysis (looking at data such as stock valuations, corporate earnings, and economic activity).
Right now, if you were to try to predict the stock market’s direction, you might get confused.
The technical analysis says the stock market is setting up for big gains this year. In contrast, the fundamental analysis paints a dire picture for the stock market. The fundamentals suggest that the stock market could crash in 2023.
Stock Chart Indicators Suggest Stocks Could Rise
The charts currently say the stock market has huge upside, with possible double-digit returns in 2023. For some perspective, look at the chart below. It plots the weekly performance of the S&P 500.
In early 2022, a downtrend began on the S&P 500 chart; the index consistently reached lower lows and lower highs. This trend was consistent throughout last year. However, in late 2022, buyers started to come in.
Then, in early 2023, the downtrend was broken, which is a bullish sign. Whenever a major trend breaks, the move in the opposite direction tends to be massive. Now the question is whether the S&P 500 will keep going up and test the 4,800 level this year.
Chart courtesy of StockCharts.com
Also, pay close attention in the above chart to the 200-week moving average, which is a trend indicator. For years, this moving average has acted as a strong support level for the S&P 500.
If you had bought shares of an index fund that tracks the S&P 500 the last two times the S&P 500 fell to its 200-week moving average—and held those shares for one year—your returns would be more than 30%.
In October 2022, the S&P 500 dropped to its 200-week moving average and bounced. It’s currently not too far from that moving average, only 15% higher. With this, investors must ask whether the pattern will repeat itself and the stock market will jump by another 15% or so in 2023.
Meanwhile, the S&P 500’s moving average convergence/divergence (MACD), which is a momentum indicator, has been trending upward and has started to enter positive territory. This says buyers are embedded, the trend is intact, and the stock market could go higher.
All in all, the charts are saying stock investors are in for a solid year.
This Ratio Suggests Stock Market Is Extremely Overvalued
For stock valuations, take a look at the cyclically adjusted price-to-earnings ratio (CAPE) ratio. This is a much better measure of the stock market than the plain price-to-earnings (P/E) ratio. The CAPE ratio looks at long-term earnings and reduces the impacts of economic cycles.
As per the most recent data, the CAPE ratio stands at 30.4. (Source: “U.S. Stock Markets 1871-Present and CAPE Ratio,” Online Data Robert Shiller, last accessed February 16, 2023.)
The current CAPE ratio by itself doesn’t really mean anything; you have to compare it to its historical average. The long-term average of the CAPE ratio is around 16.5. That means the stock market is trading about 85% above its historical valuation.
Essentially, the CAPE ratio is saying the stock market will have to come down by a lot in order to be fairly valued.
Corporate Earnings Look Dismal
One of the biggest drivers of the stock market is corporate earnings expectations. If earnings are expected to be great, you’ll see the stock market rally. If earnings are expected to be dismal, you will see sell-offs.
Corporate earnings have been anything but great lately. S&P 500 companies recently started to report their financial results for the fourth quarter of 2022. As of this writing, about 70% of the companies in the index have reported a decline in their earnings per share (EPS) of more than five percent.
The first quarter of 2023 hasn’t even ended yet, but 58 S&P 500 companies have issued negative guidance for their EPS for the quarter. Moreover, analysts project that the S&P 500 companies will report an earnings decline of 5.1% for the first quarter of 2023 and an earnings decline of 3.3% for the second quarter. (Source: “Earnings Insight,” FactSet, February 10, 2023.)
To say the least, corporate earnings haven’t been making a case for being bullish on the stock market.
Economic Activity Stalling in U.S. & Globally
In terms of economic activity, it’s pretty clear that the U.S. economy is slowing down and that the headwinds for the global economy are getting stronger.
The U.S. economic data is loud and clear that consumers and businesses aren’t too optimistic. American consumers have been pulling back on their spending on big-ticket items, their budgets are being destroyed by inflation, and their savings have plummeted. American businesses are also becoming pessimistic. There’ve been many layoffs in the technology sector, and other sectors could follow.
Globally speaking, the major economic hubs have been reporting dismal data. There isn’t really any “great story” out there. China’s economy has been slowing, the eurozone could be on the cusp of a recession, emerging markets have been going through a rough patch, and the list goes on. Don’t forget, the entire world is extremely interconnected economically and financially.
Could the stock market keep marching higher if the U.S. economy stalls and the global economy experiences a severe slowdown?
What Investors Should Know About the Stock Market
Dear reader, the dichotomy between technical analysis and fundamental analysis could be dangerous if you don’t know that it’s happening.
I believe that, for the near term, the charts might be right. The stock market could rally. Lately, market participants have been bullish; they’ve been buying stocks in the hope that the Federal Reserve will pivot and that economic activity won’t get worse.
However, underneath the surface, the problems are getting bigger. The longer the problems persist, the bigger their negative impact will be on the stock market.
Mind you, I haven’t even touched on interest rates and central banks’ monetary policies. Those factors could act as more fuel on the fire. That’s a topic for another day.
For now, it might be fine if investors choose to take a bullish view on the stock market, but they might need tight stop-losses. The stock market could fly higher in the short term, but the fundamentals eventually matter. Speaking from experience, the market tends to fall much quicker than it goes up. Stop-losses could help investors keep their profits and limit their losses in the case of a stock market sell-off.