Is a stock market recovery on the way?

The UK stock market this year has largely been a story of falling prices. The FTSE 100 is down 7% since the start of the year.

Along the way, there have been some brief rallies. But so far, these have proved to be temporary respite from a general downward movement. 

Over the last week, though, the FTSE 100 has gained around 1.25%. Is this the start of a meaningful recovery, or just another false dawn?

I think it’s the latter. In my view, the stock market is likely to continue to work its way lower until some significant earnings growth materialises and I believe that could be some time.

The stock market

Two things determine the level of the stock market. The first is corporate earnings and the second is investor sentiment.

Earnings in the FTSE 100 have been mostly stable for some time. As a result, the most recent fluctuations in UK stocks have been the result of shifting attitudes among investors.

The biggest influence on investor sentiment this year has been central bank policy. As interest rates have been rising to fight inflation, investors have turned against stocks.

It hasn’t all been bad news, though. There have been some rallies as more accommodating monetary policy has created some optimism for share prices. 

The most recent example of this has been the Bank of England announcing plans to buy UK bonds. The FTSE 100 recovered around 3% of its losses on the news before falling back. 

Share prices

I think that the stock market is likely to continue to decline before any kind of meaningful recovery comes about. In other words, I’m expecting the pattern from this year to continue.

The Bank of England has said that it is committed to bringing down inflation. As a result, I don’t anticipate interest rates coming down any time soon. 

Bringing inflation in line with a 2% target will involve tight economic conditions. That means I’m not expecting share prices to get much of a boost from improving investor sentiment.

That leaves corporate earnings as the catalyst for moving share prices higher. And rising interest rates are unhelpful here, too.

Corporate earning growth needs to be funded somehow and one way of funding it is through debt. Higher interest rates make this more expensive and more difficult.

Rising interest rates bring with them a fear of a recession. And while that possibility is on the horizon, I’m not optimistic about significant earnings growth coming through soon.

That’s why I think that the stock market is likely to go lower from here. The UK faces the dual threat of a stagnant economy and rising inflation.

I’m not ruling out the possibility of share prices rallying again. But I think that the near future involves the stock market going lower from here.

For me, lower share prices mean I can buy stocks at better prices than I could before. So I’ll be looking to invest in UK stocks if the market goes the way I’m expecting it to.