With yesterday's drop, the S&P 500 is now down almost 10% in a week, and the pain from these losses is real and strong. The constant drops are scary, and the number of people asking "Should I get out?" has gone up in the last few days.
My answer has been: Everyone needs to sleep at night, so do whatever you need to do to be comfortable.
But if you're looking at the market for longer than the short-term, it's important to remember that facts drive the market in the end, and facts did not cause Monday's (or Thursday's or Friday's) drops. It was caused by momentum, fear, and forced selling. The declines themselves are now the biggest short-term problem for the market.
Despite the selling, however, the facts remain that yesterday, on balance, was slightly positive as Fed Fund futures reduced the amount of hikes expected in 2022 by 25 bps.
Bottom line, as we demonstrate in the Market Expectations Table, the market has moved beyond the current reality (which isn’t great but it’s not a crisis or guaranteed recession either) and is now pricing in a lot of bad news. Bottom line, I want to point out clearly that since Thursday, actual news has not been negative, it’s at worst been neutral, yet stocks are down sharply. I can’t say these declines are over (they likely aren’t) but they are not being driven by actual fundamentals, and amidst this panic I want to make that very clear.
In the end, the Market Expectations Table shows that the market has moved past the current situation, which isn't great but isn't a crisis or a sure sign of a recession either, and is now pricing in a lot of bad news. Bottom line, I want to make it clear that since Thursday, the news hasn't been bad, and at worst, it's been neutral, but the stock market is still falling sharply. I can't say that these declines are over (they probably aren't), but I do want to make it clear that they aren't being caused by real fundamentals.
The market multiple range has been lowered this month because of the additional headwind on economic growth from China. Additionally, the Russia/Ukraine war is looking like it will become a long, drawn out stalemate. That largely offset the “Not as hawkish as feared” FOMC meeting, which was a small plus. Inflation and economic growth remained generally unchanged from the past month, although in next month’s MET we’ll have a better idea 1) If inflation is peaking and rolling over and 2) If Fed tightening is a real head-wind on the economy. The current market set up is worse than last month thanks to Chinese lockdowns and no progress on Russia/Ukraine, and that deterioration combined with extremely negative sentiment has the S&P 500 trading just below the lower bound of the “Current Situation” fair value band.
Things Get Better If:
China’s Covid cases decline or they relax the Zero-Covid policy.
Inflation shows more signs of peaking and starting to recede.
The Fed further confirms that rates may not rise as high as feared.
Hope for a ceasefire in Russia/Ukraine rises and economic growth remains stable, reducing stagflation concerns.
Market sentiment is very negative so if we get any of the first three events occurring, then stocks are poised for a substantial rebound (likely close to 5%). I say that because any of the first three events would reduce the risks of a global economic slowdown, which is what has been the real cause of the steep declines in stocks over the past several weeks. If slowdown risks are reduced, then we’d see the expected multiple on the market move higher as inflation would again become the primary concern, and a rally of 10% (or likely more) should be expected. Practically, any of the first three events occurring could result in a retracement of these recent declines—likely back towards 4,300-4,400 in the S&P 500.
Things Get Worse If:
China's Covid cases rise and they continue with lockdowns.
Inflation does not peak
The Fed back tracks on keeping rate increases some-what limited (including reintroducing 75 bps).
The Russia/Ukraine war expands and Economic growth starts to roll over, raising stagflation concerns.
At this point, a global recession wouldn’t just become more likely, it’d become a very likely outcome. And that would result in a more typical “recession” market multiple between 15X-17X. These events wouldn’t make a recession the automatic outcome, but investors would aggressively price in that reality. Bottom line, this outcome would open up substantial additional downside for stocks, and we shouldn’t be surprised if the S&P 500 “round trips” the entire pandemic rally (which would be around 3,500 in the S&P 500, or a little over 10% from here). Around (or near) these levels we would view this as a max-negative scenario being priced in and would view that as a potential material long-term buying opportunity.
The macroeconomic outlook has deteriorated over the past month as Chinese Covid lockdowns and no end to the Russia/Ukraine war are combining with Fed rate hikes to increase the chances of an economic slowdown. But extremely negative sentiment has now pushed stocks below what we would consider the lower bound of “fair value” and as such this market is poised for a rebound if we get even some good news in the coming weeks. But until we see real good news on 1) China, 2) Ukraine or 3) The Fed, then the path of least resistance for stocks will remain lower driven by this very negative sentiment.
And remember – the one fact pertaining to all conditions is that they will change.
Feel free to reach out to me and use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President