by Krystal Daibes Higgins, CFA
Vice President, Equity Research
Some while ago as I was preparing for my first solo overseas flight, I told a friend in the aviation industry that I disliked turbulence; the stomach-churning drops and swings were too sudden and unpredictable for my appetite. Fortunately, he gave me some comforting information: turbulence is caused by the plane moving between cooler and warmer temperature. Bumps are normal (even the ones that make your stomach drop) and will always be a part of the flying experience.
Markets also experience turbulence from time to time as they shift between various macroeconomic environments. And just like with airplanes they can also make investors’ stomachs drop. Heading into 2022 from the strong, but docile, 2021 market environment, investors saw the S&P 500 briefly enter correction territory (a decline of 10% or more) before retracing half of its decline by the end of January.
Notwithstanding 2021, market corrections are normal reoccurrences with the average decline approximately 13% in any given year. Despite their normalcy, corrections and market volatility, in general, often increase investors’ anxiety levels.
Source: FactSet
This year’s market volatility is caused by a barrage of headline news full of conflicting information for investors. On one hand, we have interest rate hikes, high inflation, continued supply chain headaches and, more recently, increasing tension between U.S. and Russia. On the other, we see decreasing caseloads of Omicron, the U.S. economy continuing its path to fully reopening, financially healthy consumers, a strong housing environment, an improving global economy, returning workers and increased spending on services—which could help alleviate the strain on supply chains over the coming year. It’s no surprise we’ve seen erratic market behavior these past six weeks.
Fundamentals Over Headlines
Fortunately, company earnings can help shift investors’ focus back to fundamentals. Amid the macro- and geopolitical backdrop, over 70% of the S&P 500 constituents have reported fourth quarter results. Of those, nearly 80% have reportedly beaten expectations with a 5% average “surprise factor” (i.e., earnings above or below analyst expectations). This compares to a long-term average of 66% beating expectations and 4.1% surprise factor.
Within the S&P 500, there are six companies that make up over 20% of the index: Meta (formerly known as Facebook), Amazon, Netflix, Alphabet/Google, Apple and Microsoft. Given these companies comprise a large weight of the index, it isn’t surprising that they receive the most attention from investors. Alphabet, Amazon, Apple and Microsoft all reported strong results that demonstrated their continued competitive advantages and structural growth characteristics. Meanwhile, Netflix and Meta saw their share prices drop more than 20% due to slowing subscriber growth and declining daily active users, respectively.
More importantly we believe it’s important for investors to remain focused on long-term earnings power and fundamentals rather than short-term news and headlines. One of the advantages of active management utilizing individual securities is being able to select businesses that are believed to be well positioned in the current phase of the economic cycle or are relatively insulated from exogenous factors and deliver earnings growth regardless of the macroeconomic environment.
Looking ahead, headlines and unpredictable earnings growth expectations will continue to drive volatility and the macro backdrop may overshadow strong company fundamentals. However, stock prices will generally follow earnings growth over the long term. It’s important to stay focused on fundamentals and remain patient as the market adjusts throughout 2022.
Takeaways for the Week
We are likely to see continued volatility as the Fed raises interest rates and valuation levels adjust
Over the long term, earnings growth drives share prices. It’s important to stay focused on long-term fundamentals