The stock market looks precarious to me. Investors seem to be expecting interest rates to come down, but this isn’t guaranteed to happen as quickly as many are anticipating.
A lot of the biggest publicly-traded companies – especially in the US – are set to report earnings this month. And I think their results could heavily influence where share prices go next.
Investor sentiment
According to a survey from Capital.com, UK investors are feeling good about stocks. Only 22% expressed a negative sentiment and 57% said they would look to save or invest an extra £10,000 if they had it.
To some extent, this is borne out in shares prices. Despite interest rates being 600% higher, both the FTSE 100 and the S&P 500 are higher than they were.
This is especially true over in the US, where the index is up 82% since February 2019. And to some extent, that means there’s pressure on earnings to justify those higher prices.
With Amazon, Apple, and Meta Platforms all reporting imminently, the stock market is going to get an idea of how businesses are doing. But I think investors should be careful what they wish for.
The risk of strong earnings
It’s natural to hope earnings come in strong. Meta, for example, trades at a price-to-earnings (P/E) ratio of 36, meaning investors are expecting significant growth from the company.
The trouble is, one of the major catalysts for the stock market is interest rate cuts. And strong earnings might convince central banks that these aren’t necessary to stimulate economic growth.
Inflation is still some way above central bank targets in both the UK and the US. So there’s an incentive to keep rates higher for longer, which isn’t good news for investors expecting cuts.
I therefore think investors should be wary of two types of stock market risk. Weak earnings are one potential danger and the chance of delayed interest rate cuts are another.
What should investors do?
To my mind, the best strategy is to look for businesses that can generate a good return, regardless of what share prices do. And a good example, in my view, is Berkshire Hathaway (NYSE:BRK.B).
The company is built to do well in any environment. Its strong balance sheet puts it in a position to take advantage of unusual opportunities – such as its recent investment in Japanese trading houses.
Even a stock like Berkshire doesn’t come entirely without risk though. Its utilities and railroad businesses are regulated, meaning returns are out of the company’s control, to some extent.
The other side of this coin though, is that those businesses are extremely difficult to disrupt. Regulation provides an almost insurmountable barrier to entry, helping to ensure stable cash flows.
Inflection point
As I see it, the current earnings season might well set the agenda for the stock market going forward. And I think it’s hard to predict how the various possibilities will play out.
That’s why I think the best strategy right now is to buy shares in businesses that can hold up well, whatever happens. Fortunately, the largest investment in my portfolio fits the bill here.
