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Three reasons stocks will fall

By Michael O’Connor, theislandinvestor.com
I can’t recall a time in my career when the outlook was so ‘uncertain'.
I write to clarify my thoughts on the market, but right now, the market noise is deafening.
For me, the economic data points to an obvious slowdown, so my head screams ‘LIMITED UPSIDE’, but my pocket tells me I have been wrong plenty of times before.
Here are three areas I am watching that will dictate where the market goes over the coming months and how you can set up your portfolio accordingly.
1. There is an alternative
Bonds have become a genuine alternative to stocks as the equity risk premium falls.
This is already playing out. More than $100bn has flowed out of stock mutual funds and ETFs on a combined basis over the past 13 weeks, one of the worst flow collapses on record while money market fund flows surge.
The narrative is simple. Why have all your exposure in ‘risky’ stocks if you can get 5% risk-free?
2. Earnings
Company earnings drive the stock market in the long run, and higher interest rates will squeeze margins and lower corporate profits over time.
- In Q4, S&P 500 companies posted an average earnings decline of 4.9% over the same quarter a year earlier. This marks the first quarterly decline since the third quarter of 2020.
- S&P 500 profit margin fell from 13.4% in Q4 2021 to 10.8% in Q4 2022.
- Forward earnings projections have fallen from +10% to +2% over recent weeks - a trend that will likely continue, (some of this is already priced in).
As company profits fall, the price investors are willing to pay to own a part of these companies falls as well.
3. Real Estate slowdown
In the US, 'existing-home sales' have been falling for 12 months straight. January year-over-year sales were down 36.9% and are now at levels last seen during the COVID low and Great Financial Crisis.
Even with supply constraints, housing affordability is far from where it needs to be for demand to return. We need to see either a big adjustment lower in interest rates, a realistic decline in prices or some combination of the two.
In Ireland, the trend is still developing. Europe is behind the US in the rate hiking cycle, so mortgage rates are still relatively low (but rising). The housing market has remained stable as a result.
There have been some signs of a slowdown in activity but no significant price movement. The number of house sales in January 2023 was 11% lower than the same month a year earlier.
However, supply issues and a lower mortgage rate relative to the US mean we are unlikely to see any significant price declines in Ireland just yet.
As rates increase, however, I expect the Irish market to come under the same pressure we are currently seeing play out in the US.
Outlook
As we move forward, the question that determines where the stock market will go changes from:
How high will interest rates go?
to
How long can rates stay this high before something breaks?
In my opinion, any market rallies we see off the back of single data releases will be short-lived - but they will happen.
Long-lasting bull markets require rapidly expanding valuations and/or strong earnings growth. I don’t see a reason for either in the data.
Of course, this is a condensed view. If you want me to help you build out and protect your portfolio, email me mike@theislandinvestor.com or scan the QR code.
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