Thrashed Stock Bulls Look to Future and See Nothing But Bad News

(Bloomberg) — It wasn’t that long ago that investors were being pilloried for rushing into stocks while a pandemic was gutting the economy. Now, with earnings estimates booming and little in forecasts to suggest a recession is hence, they can’t bail out fast enough.

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Limitless optimism has been replaced in two short years by a pervasive sense of dread, with inflation and the efforts of central banks to restrain it drowning out most other inputs. The result is months like April, one of the worst across asset classes in more than a decade, highlighted by a frantic rush to the exits among equity investors.

The consequences of their skittishness were on display the last few days, when it took projections from just a couple high-profile companies to shatter an otherwise solid earnings season and drag the S&P 500 Index to a fourth straight week of declines.

Layer in the Federal Reserve’s tightening campaign, and bulls are starting to give up on risk-asset rebounds, according to AlphaSimplex’s chief research strategist Katy Kaminski.

“For me, it’s really a long-term versus short-term issue. Longer-term, we’re seeing the pressure of interest rates be the bigger problem,” Kaminski said in a Bloomberg Television interview. “And yes, some earnings are good, but the truth is, longer-term issues are still not resolved. So any sense of weakness is going to be jumped on.”

It’s an environment that breeds volatility, with the S&P 500 ending Friday with a 3.6% drop after soaring 2.5% on Thursday, following Tuesday’s 2.8% plunge. That’s boosted the Cboe Volatility Index back above 30, while a similar measure for expected Treasury market swings is hovering near the highest level since 2020.

Both the S&P 500 and the Nasdaq 100 have fallen for four consecutive weeks.

The S&P 500’s monthly drop of 8.8% was the index’s worst April performance since 1970. In fact, it was an unusually brutal month across assets. Down 13.4%, the Nasdaq 100 suffered its biggest slump since 2008, leading a global equity selloff. The market of fixed income was not spared either, with a benchmark tracking bonds worldwide dropping more than 5% for the worst month since at least 1990.

Earnings season has only exacerbated the drama as companies navigate still-broken supply chains and the hottest inflation in four decades. The average S&P 500 stock has moved 4.2% in either direction after reporting earnings this quarter, the most since the last period of 2011, according to data from Goldman Sachs Group Inc. That compares with an average price change of 3.4% in the prior 65 quarters.

Despite April’s market turbulence, analysts kept upgrading their estimates, a sign of faith in corporate America’s earnings power. The forecast per-share profits increased by roughly $2 each for this year and next, reaching $227.5 and $248.4, respectively. But investors can’t kick their skepticism that corporate America will be able to deliver.

“There’s a big question mark about earnings,” Anastasia Amoroso, chief investment strategist at iCapital. “The other force that is so significantly different is the Fed, which has been a huge tailwind for equities, but is now capping any valuation upside.”

Equity funds suffered outflows for three straight weeks through Wednesday, the longest streak of withdrawals since August 2020, data compiled by EPFR Global show. Over the span, $32 billion was pulled out. That’s a stark contrast from the first three months of 2022, when all but three separate weeks saw inflows, with funds sucking in almost $200 billion in total.

The central bank is widely expected to deliver the largest interest-rate hike since 2000 next week at May’s policy meeting, with traders on the cusp of pricing in a 75 basis point jump in June. Bonds have sold off aggressively amid the recalibration, with 10-year Treasury yields trading near 2.92% after entering the year around 1.5%.

With bonds and equities selling off in unison, financial conditions — a multi-input measure of market stress — have started to narrow, reaching levels last seen in 2018, excluding 2020’s coronavirus shock. Given that the Fed’s tightening cycle only kicked off in March, there’s more compression to come — and that’s a difficult environment for equities, regardless of today’s data points, according to Chris Brightman, chief executive officer at Research Affiliates.

“People are seeing a recession coming, people are seeing liquidity leaving the markets and people are forward discounting that. Remember, the Fed has really not even started,” Brightman said in an interview at Bloomberg’s New York office. “So what you have is markets discounting the coming tightening of financial conditions, and that’s what caused the stock prices to go down.”