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On Thursday, the S&P 500 set a new high.
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This year’s stock market has been on a tear. However, a number of things have the ability to bring the party to a close. The S&P 500 index has enjoyed its best first half of the year since 1998, and it shows no signs of slowing down. The index completed June with a year-to-date gain of 14.4%, breaking numerous records over the month and closing at a new high on Thursday.
According to Nick Colas, co-founder of DataTrek, there are a few critical dangers that might turn everything around. First, there’s the risk of an oil price shock, as crude prices haven’t showed any signs of abating. Even as expectations build that OPEC will raise production, WTI crude oil is up 56 percent year to date and hit a new multi-year high on Thursday. If oil prices rise to a high enough level, inflation could rise to a level that, if sustained, would lead consumer demand to collapse, exceeding Federal Reserve projections.
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“Suddenly rising oil prices” is at the top of Colas’ list of stock market fears. “Rapidly rising oil costs will force US inflation to exceed the Fed’s target while simultaneously putting pressure on the American consumer.” Both of these factors might hurt the stock market, which has benefited from the Fed’s supportive monetary policy for a long time, particularly if the Fed signals that interest-rate hikes may occur sooner than expected. To avoid spooking the market, the Fed will have to walk gently while addressing rates, according to Colas. A second risk, according to Colas, is “Federal Reserve misunderstanding about anticipated policy changes and/or hiking interest rates too aggressively.” For example, the S
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In late 2018, the stock market plummeted 18 percent in three months as the Federal Reserve hiked interest rates, despite the market’s expectation that rates would remain unchanged at the time. The other hazard to stocks, according to Colas, is slowing earnings growth. According to FactSet, as the economy normalizes and the post-pandemic recovery eases, earnings growth for the average S&P 500 firm will fall to 11 percent in 2022 from 36 percent in 2021. However, S&P 500 equities are currently trading at 21.5 times projected earnings for the next 12 months, which is still higher than the index’s pre-pandemic multiple. Stock valuations will eventually need to properly reflect the predicted slowdown in profits growth, resulting in lower stock prices. “Valuations are currently high enough that peaking earnings may pose a greater risk than previously,” Colas says. To contact the editors at Barron’s, send an email to editors@barrons.com./n
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