S&P 500 to Dip Further, Focus on High Margin Stocks

Key Takeaway

• S&P 500 struggles amid volatility, trading at high valuations with investor confidence low due to inflation and interest rate concerns.
• Investors advised to focus on S&P 500 companies with high operating profit margins like Visa, CME Group, and Broadcom for stability.
• Market expected to fall further in 2024, with specific stocks like GameStop and Bank of Hawaii highlighted as facing additional declines.

Market Volatility Persists

The stock market is currently experiencing a period of significant volatility, with the S&P 500 and other indexes struggling to maintain consistent gains. Despite opening in positive territory on several occasions, these indexes have frequently ended the day in the red, indicating a rapid response from sellers to drive prices lower. This pattern suggests a prevailing lack of confidence among investors that the market will achieve sustainable gains. The S&P 500, for instance, has been trading at about 20 times the aggregate per-share earnings analysts expect its component companies to produce over the next 12 months, a valuation at the high end of its range since early 2022 when the Federal Reserve began increasing interest rates.

Inflation and Interest Rates Impact

The stubbornly high rate of inflation has led to expectations that the Federal Reserve will not soon cut its target for the federal-funds rate. This stance has, in turn, caused market interest rates to rise in recent weeks, potentially slowing economic growth and corporate earnings. This environment has made investors wary, particularly as it affects smaller companies more severely. Smaller-cap indexes, for example, have a higher percentage of stocks that have been running at net losses recently compared to the S&P 500. This situation has led investors to show a strong preference for profitable names, as noted by Dennis DeBusschere of 22V Research.

Seeking Safer Investments

In response to the current market conditions, investors are advised to focus on companies that are better positioned to withstand economic downturns. A screening for S&P 500 companies with the highest operating profit margins in 2023 revealed businesses that are likely to continue generating profits even if sales decline. These companies, including Visa, CME Group, and Broadcom, among others, present minimal risk of defaulting on debt payments, making their stock prices less volatile. This approach suggests a strategic shift towards higher-quality and more profitable investments during uncertain times.

Analysts Predict Further Declines

Julian Emanuel from Evercore ISI has indicated that the stock market is likely to experience further declines throughout the rest of 2024, following a retreat from an all-time high last month. Emanuel points to stalling progress on inflation, uncertainty around Federal Reserve interest rate cuts, and election volatility as factors that will pressure the stock market. Despite these challenges, Emanuel sees a potential buying opportunity when the S&P 500 reaches his target price level. Meanwhile, a CNBC Pro screen identified several stocks already in correction territory that may face further downside, including GameStop, Advance Auto Parts, and Bank of Hawaii, among others.