As we all sit here and see the economy struggle, with talk swirling of a possible recession, it is important to keep focus on what could happen in the market and how to deal with it. Market volatility, especially volatility in a downward market, stirs a lot of emotions for folks. These emotions may instill a sense of fear, which cause people to make rash decisions that can realize the problems they were looking to avoid in the first place.
This is the time to work through different scenarios and update a well-organized plan… or develop a plan, for those without one! Let’s dig into a scenario on the S&P 500 as viewed through the S&P 500 Index (SPX).
Earnings growth for the second quarter of the year has been forecast to be 4.3% for the S&P. While this represents a slight increase over the 4.1% originally forecast for the quarter, if realized it will represent the lowest actual quarterly growth rate since the fourth quarter of 2020, which was 3.8%.
Regarding valuation forecasts, the forward 12-month P/E ratio for the S&P 500 is hovering around 16 (15.8) based on the June 15 close. A quick brush-up- forward P/E ratios are based on forecasted earnings. While the P/E will change when actual earnings are known, the forward look acts as one indication on the direction of the earnings for a particular company or aggregate market. The current forward 12-month P/E ratio for the S&P is below the five-year average (18.6) and below the ten-year average (16.9).
Now let’s look at trailing P/E ratios for the S&P. As opposed to forward P/E ratios, trailing P/Es (sometimes referred to simply as the P/E ratio) reflect the actual performance of a company or aggregate market through a ratio of current price to actual earnings. The current trailing P/E ratio of the S&P 500 is about 18.5. The average trailing P/E ratio hits about 11.7 when a bear market bottoms (with an historical range of between 5.7 and 17.6).
What does that mean? First, it means that a bottom to the market will come eventually- we won’t know exactly when, but it will come. Second, let’s look at a scenario in which the S&P hits a trailing P/E of 12 (just above the 11.7 average bear market historical bottom figure)… the S&P is currently trading around 3,800 (with a P/E of about 18.5), if the P/E compresses to 12, that would bring the S&P to around 2,600.
Will the S&P hit 2,600? No one knows, but the market will bottom at some point and the idea is to have some protection in a scenario in which it happens. It’s especially important to manage the risk of assets you need in the next five years. Do the math- what would your portfolio look like if the S&P falls to around the 2,600 range? If you are uncomfortable with that figure, then take steps now to provide protection through a well-organized plan that accounts for potential downturns, while also providing a mechanism to help get back into the next market upswing.
Experiencing fear without a well-organized plan will often hurt investors more than the actual markets will. Thinking this issue through now and developing a clear rational plan will help keep bad decisions at bay, like selling at the bottom and making panic moves. Reach out if you or anyone you know needs assistance in developing a financial plan.
For those inclined, here is an in-depth earnings report on the S&P 500 for the second quarter. Enjoy- and let me know what you think!
Click here- FactSet- Earnings Insight
~ Brian Kasal- The Leadership Matrix
Also, check out my Leadership Matrix post on the FourStar investment philosophy- “We have maximum portfolio protection levels now”
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