U.S. Stocks: Great(er) Expectations

Written by: Global Thought Leadership | February 02, 2018

Source: Bloomberg, Standard and Poor’s, Federal Reserve, Legg Mason, Jan 25, 2018. Projections provided by Standard and Poor’s as of 1/25/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The Bottom Line

  • Inflation and earnings are major market drivers – and expectations for both have a profound impact on today’s prices.
  • For inflation, financial markets provide a relatively clear signal about current expectations:  the “breakeven” inflation rate, which is the level of inflation implied by the difference in prices between regular and inflation-adjusted Treasuries five and ten years into the future.  
  • Not surprisingly, the Federal Reserve follows this signal closely, and produces its own estimate of these values. The Fed’s most recent figure – 2.0571% on January 26 – implies the Fed will be able to meet or beat its stated target of 2% inflation over the next five years.
  • Corporate earnings are more difficult to predict. But Standard and Poor’s does provide estimates for its S&P 500 Index, which now imply operating earnings1 for the index will grow at over a 16% annual rate by the time the current earnings season concludes – and will continue to grow at that rate or better for at least the following two years.
  • Corporate operating earnings are themselves affected by inflation, as costs of production rise. But at low to moderate levels of price growth, the effect can add to earnings rather than detract; inflation affects what companies charge for their products/services as well as the prices they pay..
  • But the effects of inflation on earnings vary widely, depending on a company’s quality; a well-managed balance sheet can generate operating earnings growth in a wide variety of conditions.
  • It takes an astute, analysis-driven investment manager to do the homework needed to tell the difference between beneficiaries of the current environment and those companies that are less able to change with the times.
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Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

U.S. Treasury Inflation Protected Securities (“TIPS”) are bonds that receive a fixed, stated rate of return, but they also increase their principal by the changes in the CPI-U (the non-seasonally adjusted U.S. city average of the all-item consumer price index for all urban consumers, published by the Bureau of Labor Statistics). TIPS, like most fixed income instruments with long maturities, are subject to price risk.

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.