Traders assess chances of positive market outcomes on Ukraine, the Fed and inflation

Published Thu, Mar 3 20229:51 AM EST

Federal Reserve Chairman Jerome Powell threaded the needle perfectly on Wednesday by supporting a quarter-point rate hike and saying the Fed would move "carefully" on future hikes. Powell greatly reduced the market's anxiety that he would overshoot and kill the growth outlook. Now what's next for stocks? Russia's invasion of Ukraine remains a major risk factor, but now the focus for stocks will turn to how strong the spring "reopening" will be — and the inflation impact on the reopening. Will sky-high prices for gas, electricity — even hotel and clothing prices — cause a backlash that will reduce demand? How might "demand destruction" impact earnings? Earnings outlook depends on the inflation outlook The concern is that should consumers balk at high prices, corporations will lose control of their ability to continually raise prices, which will cause profit margins to contract. Profit margins for the S & P 500 have remained historically high, in the 12%-13% range. Remarkably, 2022 earnings estimates have been very stable through January and February. Earnings for the S & P 500 are expected to be up 7.8% this year according to Refinitiv, essentially unchanged from expectations on January 1, when they were expected to be up 8.4%. A sudden change in demand based on high prices could change that outlook. S & P decline is due to multiple contraction Earlier this week, the S & P 500 was down close to 10% for the year. Almost the entire decline has been due to a contraction in the S & P multiple, not a decline in earnings estimates. The forward multiple on the S & P has gone from roughly 21 times 2022 estimates at the start of the year, to roughly 19, a 10% drop. The multiple (P/E ratio) is the "speculative" element in the market; it is what investors are willing to pay for a future stream of earnings. That multiple will typically expand during times of economic growth because traders believe earnings will improve, and will contract during periods of slower or no growth, as well as during periods when the Fed is aggressively hiking rates. Any good news? There are several potentially positive outcomes. First, some resolution of the Ukraine crisis would remove a major "known unknown." Second, should the spring "reopening" continue strong into the summer, investors may again seek to expand the market multiple and raise stock prices. Finally, consumers balking at high prices and causing some disruption for certain corporations (particularly those in the consumer staples, travel and energy space), may be the best way to break the inflationary spiral. "Just say no" could become a mantra for fed-up consumers this summer.