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Equity Return Potential Insights

By Richard "Crit" Thomas, CFA, CAIA
U.S. Equities
Share:
asset allocation and equity risk

Equity Return Potential

Conclusion: We believe equities will continue to struggle in the near-term until it becomes clear that the Fed is near the end of policy tightening. Visibility is low as to when this will occur; it could happen later this year or sometime next year. We believe that earnings estimates need to come down and it is likely that prices will follow. We are looking for an opportunity to increase equity exposure. Right now, we are doing this through cheaper small- and mid-cap stocks. Lower valuations or improving fundamentals would enhance the return prospects for large-cap stocks.

Market Cycles

The S&P 500® officially entered a bear market in June. While the bull market that started in 2020 was short in duration, the return was near the historical median and surpassed five past bull markets.

Bull and Bear Markets Since 1928

Economic Cycle

The speed of this cycle speaks to the truly unique circumstances surrounding it. Customarily, the economy takes the elevator down and the stairs back up. High levels of cash savings and pent up demand have allowed for a rapid economic recovery. We will let our model speak for itself, though we were less confident in its signal given that the current unique economic backdrop is inconsistent with historical cycles used to create the model. Instead, the signal proved useful. We believe that we are likely to enter a mild recession later this year or early in 2023.

Stage of the Economic Cycle Model

Fundamentals

We see earnings growth as the key to the market cycle, with profit margin expansion and contraction being the key source of earnings cyclicality. The previous short bull market saw strong earnings growth with profit margin expansion being the dominant driver. Profit margins rose from 10% to over 13% during that cycle. We believe that further margin gains from here will be difficult given the likelihood of recession, though they are implied to move higher in analyst forecasts. Our proprietary EPS model suggests that S&P 500® EPS will decline over the next 12 months.

S&P 500® Index EPS Model and S&P 500® Index Profit Margin (trailing 12 months)

Valuation

All valuation measures have their flaws, this is why we use numerous and different measures. While they have come down, valuations still remain high in a historical context by almost every measure. This is mainly due to the high starting place. Even if we substitute forward estimates, valuations look high, and we question the durability of these forward estimates.

Valuation Measures and S&P 500® Index Valuation Multiples

Touchstone Equity Risk Model

The Touchstone Equity Risk Model brings together the economic cycle, market fundamentals, and valuation considerations. It is a way to measure potential upside based on fundamentals, though we recognize that sentiment can carry the market beyond what the fundamentals suggest. Despite some of the unique aspects to this cycle, this model was helpful in indicating trouble ahead for the market.

Touchstone Equity Risk Model

Glossary of Investment Terms and Index Definitions


This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.

Not FDIC Insured | No Bank Guarantee | May Lose Value

crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.

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