'Catastrophic' Stock Market Crash Isn't Over—Here's How Much Worse It Could Get

Topline

As a weeklong sell-off that’s pushed major indexes down into bear-market territory intensifies, investment banks are warning clients the worst may be yet to come, with some experts warning the S&P 500 could plunge as much as 11% more if corporate earnings continue to disappoint as the Federal Reserve begins raising interest rates.

“It’s too early to be bullish,” one Morgan Stanley analyst said Monday.

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Key Facts

Dragged down by a fifth-straight day of steep losses in the tech sector, the S&P 500 fell nearly 4% to 4,236 Monday morning, pushing the index down more than 10% for the year.

A “disappointing” start to fourth-quarter earnings season could spell trouble for stocks this year, Goldman Sachs’ David Kostin wrote in a Monday note, forecasting the S&P could plunge as much as 11% from Friday’s close (to 3,914) if higher interest rates and the reduction in Fed stimulus push annual corporate profits down 4% from 2021.

Morgan Stanley’s Michael Wilson struck a similar tone, telling clients on Monday to “hunker down for a few more months” as slowed earnings growth joins monetary policy uncertainty as primary market concerns.

“It’s too early to be bullish,” Wilson said, warning the S&P could plunge another 10% while pointing out the “most speculative parts” of the market have been hit the hardest, with names like Peloton down 75% in six months.

As inflation falls once the Fed starts hiking rates, Wilson says he’s “most bearish” on consumer goods, apparel and housing-related stocks that have benefited from rising prices.

Kostin says some sort of catalyst—such as a slowdown in inflation—will be necessary to curb the broad-market sell-off, but Goldman economists don’t expect prices will cool down until the second quarter; other potential catalysts include an “extremely strong” earnings season or a Fed policy pivot.

Crucial Quote

“Winter is here, and the damage under the surface has been enormous and even catastrophic for many individual stocks,” Wilson said. “The Fed is serious about fighting inflation, and it’s unlikely that it will be turning dovish anytime soon given the seriousness of these economic threats and the political support to take action.”

Contra

Not everyone’s bearish on the market’s short term. In emailed comments Monday, Frank Panayotou, a managing director at UBS Private Wealth Management, said the dip in stock prices this year “seems overdone and represents a buying opportunity for long-term investors.” He points out stocks have historically performed well in the months leading up to the Fed’s first rate hike, but he cautions markets will be more volatile than usual. “Investors need to be prepared for more volatility and overall more muted equity market returns than we have been accustomed to in recent years,” he said.

What To Watch For

A slew of events will surely test the market this week. On Wednesday, the Fed is expected to give an update on when it may move to raise interest rates. Additionally, big-tech companies like Apple, Microsoft and Tesla start reporting fourth-quarter earnings on Tuesday.

Key Background

The Fed sparked a broad sell-off this month by cautioning it will move more quickly than previously expected to reverse policy meant to bolster the economy during the pandemic in an effort to combat rising inflation. A worse-than-expected start to earnings season has since intensified the drawback, with Netflix crashing 22% on Friday after reporting a slowdown in subscription growth. Though Fed officials last month said they project only three interest rate hikes this year, Goldman Sachs chief economist Jan Hatzius said Monday he expects the central bank will actually hike interest rates four times this year (starting in March) given a “greater sense of urgency” than he previously expected from the Fed this month.

‘Catastrophic’ Stock Market Crash Isn’t Over—Here’s How Much Worse It Could Get