Innovator ETFs: What to Watch- Valuations are Down, Now What?
Contact

July 15, 2022

What to Watch - Valuations are Down, Now What?

Asset managers love to promote the potential upside for stocks, especially amidst a bear market. It encourages clients to remain invested and focus on the long term. While there is tremendous value in remaining invested, the reality is, drawdowns matter. Clients have goals, needs, and expectations that may not have the same timeline as the market. This is one of the reasons we are so adamant about seeing the whole field, and remaining in control of risk amidst growth opportunities.


Historical Returns Following a Sell-Off- Interesting, but Context is Key

After a brutal first half of the year, there has been a lot of commentary published showing market returns following large historical drawdowns (example below). Certainly, encouraging perspective and helpful to keep client emotions in check, however, as with everything context is key. In today’s market, we are more concerned with the drivers of the sell-off and what risks the drop in asset prices has and has yet to shake out.


Source: Yahoo Finance, 07/14/2022. Past performance is not a guarantee of future results. The chart represents periods of the S&P 500 Index from 10/21/1957 – 3/12/2020. The chart is for illustrative purposes only and is not indicative of any actual investment. The chart does not account for payment of fees and expenses.

Valuations are Crumbling on Higher Rates

Contracting valuations have been the biggest driver of the sell-off this year. As shown in the chart below, the forward price/earnings ratio of the S&P500 has moved nearly in lockstep with the performance of the index itself. What has moved valuations? Rising interest rates have been the key, as investors apply the higher discount rate to future earnings (see chart below).


Source: Bloomberg LP, 6/30/2022. Past performance is not a guarantee of future results. The chart is for illustrative purposes only and is not indicative of any actual investment. Indexes do not charge management fees or brokerage expenses and no such fees or expenses were deducted from the performance.


Source: Bloomberg LP, 7/13/2022. Past performance is not a guarantee of future results. The chart is for illustrative purposes only and is not indicative of any actual investment. Indexes do not charge management fees or brokerage expenses and no such fees or expenses were deducted from the performance.

Valuations May be Lower, but Earnings Estimates Have Yet to Reflect a Slowdown

Overall, lower valuations are encouraging. While the market may not be cheap in a historical context, the good news is, it is no longer valued at the extremes we have seen over the past few years.

However, despite all the challenges presented by high inflation and slowing growth, earnings expectations remain high. Even margin growth, which has been the backbone of earnings growth, is expected to continue, despite rising input costs and a tight labor market. So, while valuations may be more favorable than they were, the market does not appear to have priced in any potential shortfall from earnings.

The Bottom line

We see the risk a slip in earnings could present and are mindful of the potential downside that could follow. The Fed is actively trying to slow growth to get inflation under control and slower growth will eventually make its way into the earnings data. Current expectations are optimistic and leave little margin for error. We continue to focus on the balance between near term drawdown risk and long-term growth.



 
Leading the Defined Outcome ETF Revolution™
Investing involves risk. Principal loss is possible. All rights reserved. Innovator ETFs are distributed by Foreside Fund Services, LLC.
The Funds' investment objectives, risks, charges and expenses should be considered before investing. The prospectus contains this and other important information, and it may be obtained at innovatoretfs.com. Read it carefully before investing.
Innovator ETFs®, Defined Outcome ETF™, Buffer ETF™, Enhanced ETF™, Define Your Future™, and other service marks and trademarks related to these marks are the exclusive property of Innovator Capital Management, LLC.
Copyright © 2022 Innovator Capital Management, LLC  |  800.208.5212  |  View our Privacy Policy and Terms of Use