While the steep drop in the S & P 500 this year suggests that stocks are cheap, finding value is still not easy. Additionally, corporate earnings present another source of risk.
The Risk of Anchoring Bias
One mistake investors often make buying stocks that seem cheap simply because they have fallen significantly. This is known as anchoring bias. The market lost its fundamental moorings in 2021, and this risk is still present as we enter 2023. While the S&P 500 trades at a reasonable multiple of 17x forward earnings based on consensus estimates, there are many downside risks to corporate profits in the coming year. Earnings estimates for 2023 have also been trending downward.
The Risk of Normalized Corporate Profit Margins
Another concern is the potential for corporate profit margins to return to normal levels. Currently, corporate profit margins are at their most elevated level in 70 years. If and when the market prices in more normalized margins, this alone could drive further downside. Assuming margins return to pre-pandemic levels, the S&P 500 would be trading at over 20x expected earnings. This multiple assumes relatively smooth sailing and multi-year profit growth, which may not be guaranteed or even likely.
Too Many Risks to Ignore
In addition to the risks mentioned above, U.S. multinational corporations are facing stronger dollar and supply chain issues worldwide. Political risks, such as the potential for higher taxes, are also present. While 2023 may be a better year than 2022, it is important for investors to remain cautious and carefully consider all of these risks before making investment decisions.
