Topline
As the market struggles to brush off some of its worst losses in more than a year, a growing number of experts are warning more stocks could tumble into bear market territory as the Federal Reserve unwinds its pandemic-era economic support—even if inflation subsides more quickly than expected.
“Be careful what you wish for,” one Morgan Stanley analyst cautions of lower inflation.
Key Facts
While major stock market indexes plunged as much as 2% Tuesday, analyst Tom Essaye of The Sevens Report warned clients he remains “cautious” on the S&P 500 as stocks struggle to stabilize, pointing to “relentless selling” on Friday as a potential predecessor to a sharp downturn of as much as 5%.
In a Monday note, Morgan Stanley’s Michael Wilson said the Friday plunge, which saw the Dow tumble nearly 1,000 points for its worst day since October 2020, indicates the market is moving to a “much broader sell-off phase,” during which stocks in typically resilient industries—such as consumer staples—fall.
“The S&P appears ready to join the ongoing bear market,” Wilson said, cautioning that materials and energy stocks—two of the year’s top-performing sectors—have started to post “eye-popping” losses, while defensive stocks (such as in consumer staples) have gotten “expensive” relative to earnings.
In another potentially bearish sign for stocks, the analyst said inflation has likely peaked after reaching a 40-year high last month, thereby taking some pressure off the Federal Reserve as it hikes interest rates, but also meaning lower sales and earnings growth for companies benefiting from the price hikes.
For many companies, it “could be painful” if inflation declines swiftly and sharply, particularly in the materials and energy sectors, which have benefited from rising commodity prices, Wilson says, adding: “Be careful what you wish for.”
Despite tighter Fed policy and slowed earnings growth, Wilson believes large-cap pharmaceutical and biotechnology stocks—such as Merck and Eli Lilly—should persevere, helping to drive the S&P’s performance higher, thanks in part to relative low valuations and stable dividend yields.
Crucial Quote
“Inflation is peaking but that’s not bullish because it means [profit] margins and [earnings] have peaked too,” Wilson said Monday. “The market has been so picked over at this point, it’s not clear where the next rotation lies. In our experience, when that happens, it usually means the [S&P] is about to fall sharply, with almost all stocks falling in unison.”
Key Background
The reopening economy, fiscal stimulus and historically low interest rates helped fuel one of the strongest starts to a bull market ever during the pandemic, but stocks have struggled this year as the Fed raises rates and unwinds economic support to ease decades-high inflation. Meanwhile,Russia’s invasion of Ukraine has only tacked on to the uncertainty. After rising 27% in 2021, the S&P has fallen 12% this year, while the Nasdaq has hit bear-market territory, plummeting 20%. “When the market is grappling with too many things at one time, it’s generally a headwind, meaning the more managers have to discount too many issues, the more they have to lighten up on risk,” RTM Capital Advisors’ Mark Ritchie II told Real Vision on Monday, adding that he’s particularly worried of a “secular bear market” in which stocks struggle for years.
Contra
Since 1955, the S&P typically performs well in the nine months after the Fed first hikes interest rates, before performance begins to moderate, Ally analyst Brian Overby said in a Tuesday note. “Thinking longer term, remember that over the last four decades, the S&P produced positive returns through six tightening periods,” he adds.
Further Reading
Dow Plunges Nearly 1,000 Points In ‘Brutal And Ugly’ End-Of-Week Selloff Spurred By Hawkish Fed (Forbes)
This Recession Indicator Is Flashing Warning Signs As Fed, War And Oil Threaten Economic Recovery (Forbes)
Source: https://www.forbes.com/sites/jonathanponciano/2022/04/26/bear-market-looms-as-relentless-selling-batters-stocks-not-even-lower-inflation-can-help-now/