Tough Times Ahead for the S&P 500

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The market has been defined by adverse economic conditions in 2022, and the S&P 500 index has been no exception. The sectors in the S&P 500 are declining in terms of earnings, while the outlook for most of the stocks making up the index is bleak due to increasing inflation, climbing interest rates and weakening market sentiment. Furthermore, most of the verticals included in the index are expected to struggle with fundamental growth during 2023 as well. To top it off, further inflationary pressures and interest hikes look set to impact the index adversely for the next few quarters.

Thus, while many investors may consider the SPDR S&P 500 ETF (SPY), an ETF that tracks the S&P 500, to be the “easy mode” of investing, I believe that may not be the case in 2023.

Tough macroeconomic conditions punish the S&P 500

The SPY ETF tracks the S&P 500 index, which implies that any effect on the ETF is roughly proportional to the effects on the index itself.

According to a FactSet report, the companies in the S&P 500 showed a 5.6% decline in earnings per share in the first two months of the fourth quarter of 2022. Moreover, 10 out of 12 sectors in the S&P 500 have shown declining revenues in the same period.

The Materials sector covers 2.77% of the S&P 500 at the time of writing, and its earnings declined by 21.3% in the period mentioned above. The Consumer Discretionary segment showed a 12.2% decline in earnings and covers 9.82% of the S&P 500. The kicker is that the index has the most in the Information Technology sector at 25.74%, and its earnings declined by 8.2% per share.

The Covid pandemic has caused an unprecedented shift in consumer preferences and hastened the digital transformation of numerous sectors, dramatically altering the global economy and causing a bubble-and-burst in related stocks. Sector investment risks remain high due to anticipated layoffs, reduced consumer spending and contracting business investments.

Financial authorities also took steps to mitigate the impact of Covid on the economy with support measures such as rate cuts and direct stimulus payments; however, we were always going to have to pay for the stimulus measures eventually.

Sectors with the most concentration are not expected to do well in 2023

The top five sectors by weight in S&P 500 are Information Technology, Health Care, Financials, Consumer Discretionary and Industrials.

According to Fitch Ratings, the U.S. tech sector is estimated to sink lower in 2023 due to price corrections. The firm’s base rating case forecasts declines in the high single digits. In another report, Fitch believes that the Consumer Discretionary sector will face hurdles due to lower consumer spending growth in 2023.

Moreover, according to EIU, the Health Care and Financial sectors are expected to face challenges in the future, especially the latter with weakening economic output, rising interest rates and international political tensions. The Energy sector outperformed most of the markets in the S&P 500 index and provided some cushioning for S&P 500 ETFs this year. However, its growth in 2023 is expected to slow down to only 1.3%.

Interest rates aren’t coming down

Earlier this month, Federal Reserve Chairman Jerome Powell said that the interest rates will still increase as the fight against inflation is not over. He said that we still have some ways to go. Later, the Federal Open Market Committee declared a benchmark target rate between 4.25% and 4.50%, increasing by 50 basis points. In addition, the estimated rates would reach 5.1% in 2023 before coming down in 2024.

On top of that, the unemployment rate is expected to reach 4.6% in 2023, compared to 3.7% in the current year, and gross domestic product growth is expected to slow down by 70 basis points from September to 0.5%.

The above-mentioned factors will likely pressure consumer spending, leading to lower revenue and earnings.

Analysts’ predictions usually miss the mark

Wall Street has predicted a slight upside to the S&P 500, but its previous estimates for the index during recessionary periods have not been so accurate. During the Financial Crisis, for example, analysts missed their estimates by 92% for the index. More recently, Wall Street was originally set to estimate the S&P 500 would hit 5,264 by the end of 2022. The index closed at 3,844.82 on Dec. 26, with the SPY ETF trading at $382.91 that same day.

Currently, the average target for S&P 500 index stands at 4,031 for the end of 2023. Wall Street’s estimate might come true in the future if the global economy does not face a recession but merely stagnates instead. On the other hand, according to the Chief Economist of the Conference Board, 98% of CEOs predict that a recession will likely hit the U.S. economy in the next one to one and a half years.

Conclusion

The S&P 500 has declined substantially this year, implying that the broader market did not perform well. In the fourth quarter, most of the sectors in the S&P 500 ETF are facing challenges, and according to several reports, the index’s most-weighted sectors are expected to decline even more or show insignificant growth. Moreover, the bullish case for S&P 500 is not helped by the fact that interest rates and inflation are expected to increase more. Wall Street’s projections seem too optimistic when we consider that the majority of CEOs predict a recession soon.

This article first appeared on GuruFocus.