The Dow Jones Industrial Average and S&P 500 Index suffered just five straight days of losses and their worst weekly performance since – hold on – June. Investors went into the summer and made some gains in stocks and left the summer with a similar sell-off. Is there more in there? Is the big one – that the stock market correction bears have been waiting for – to finally fall?
Many of the main factors cited for a potential sell-off are known to investors, which means it is harder to see at this point how they would trigger a correction at that point. There is the delta variant. There is the rejuvenation and shift in central bank policy of the Federal Reserve amid a sudden slowdown in employment and economic growth. There’s the latest political headline – new arguments in Washington, DC over a corporate tax hike and a possible stock repurchase tax to help fund President Biden’s spending plan.
And there’s the problem that stock has left behind with every new record during this bull market (and the bull market that preceded or, depending on your view, was interrupted by the pandemic): stock valuations are high.
There are also short-term pressures to consider: the “seasonal choppiness” of the decline that market strategists believe is real, and the recent downgrades of US stock markets by the major Wall Street banks that could keep stocks under pressure, especially at this for many courses the youngest money coming into the market from retail investors. But it’s always more likely that something investors don’t see coming (like a pandemic) will cause a historic sell-off than anything investors already know.
That makes technical market indicators and the historical performance of the S&P 500 a reasonable way to gauge whether investor confidence will survive the final round of selling.
Johannes Eisele | AFP | Getty Images
For Keith Lerner, co-chief investment officer and chief market strategist at Truist, the history of the S&P 500 suggests that the bull market is not over yet, even if profits are modest.
Since 1950, there have been 14 years in which the market rose more than 15% through August. By the end of the year, stocks had gained an average of another 4% and rose in 12 of the 14 cases.
Sales of shares are to be expected
Setbacks are to be expected. The largest pullback in 2021 was around 4%. This is not typical, according to Lerner’s review of the data. The only two years in the historical record that the S&P 500 didn’t see at least a 5% decline were in 1995 and 2017. And history goes that fast-emerging gains must slow down. In his customer research, Lerner finds that the current bull market has increased 102% in 1.4 years, compared to the average bull market gain of 179% in 5.8 years since 1950.
But after what Lerner calls the “evidential approach” in the technical indicators and macro contexts, the message for investors – not traders looking for any short-term move – is that US stocks will still be for the next six years can rise up to 12 months.
Last week’s losing streak is, in his view, one of the strongest starts to the year in several decades, no cause for concern. Often times when the market moves a lot the automatic reaction is to end up going negative, but Lerner says investors shouldn’t be afraid of strength as long as it is supported by fundamentals. “A trend in motion is more likely to stay in motion,” he said. “The carousel of worries keeps spinning, and when one concern recedes, another emerges to take its place. There is always something to worry about … there can always be something that we don’t talk about today that can knock us aside. ”
Even if the Black Swan event doesn’t happen, that doesn’t mean there won’t be 3% to 5% corrections. “That’s the price of entry to the market,” said Lerner.
That doesn’t mean investors should never take tactical steps, but he does say that it is better for the majority of investors to focus on the next big step in the longer term than the next step traders take.
A slowdown in economic growth is not growth
The economy may lag behind the rosiest of expectations for a roaring 20s, but Lerner’s focus is the fact that slower expansion is still not a recession, and stocks rise 85% of the time during times of economic expansion. Stocks are highly valued, but he noted that the S&P 500’s price-to-earnings ratio hasn’t hit new highs this year despite the overall market.
“Valuations are still high, so we don’t expect strong price-earnings expansion and then earnings growth so stocks can’t grow at the same pace.” However, he added that analysts underestimated earnings power overall after the pandemic crashed.
This is what happens after recessions, it happened after 2009, he said: estimates are trimmed too far and corporate profits come back faster than expected as companies cut costs and focus on efficiency. If the economy is fragile now, it is in the midst of a strong rebound from lows and GDP that are driving more sales and more of those sales flowing into the bottom line. “And that’s why we have record corporate profits,” said Lerner.
One of the factors that should worry investors is the slowdown in growth. After being positive for over a year, the Economic Surprise Index has turned negative. “And deeply negative,” said Lerner. This is an indication that after a year where investors and economists underestimated strength and the numbers beat estimates, now with Covid concerns and an economic slowdown, the data was surprisingly down.
But that’s not a red alert. “It just means, from our point of view, that things have caught up with expectations. But that’s a slowdown. We’re seeing a climax, but it will stabilize,” said Lerner.
Exceeding peak growth does not mean weak growth, and relative opportunities in the market remain more of a focus than the cheapest asset. “There is no such thing as ‘cheapest good’ today,” he said.
The technology-oriented S&P 500 has internal problems
He sees relative opportunities within the S&P 500. The S&P 500 overall wasn’t as strong as its highly weighted tech stocks in the final leg up to the recent highs. The S&P 500 Equal Weight Index is up less than 3% since last May as mega-cap tech stocks took the lead. That was a reversal from early 2021 when inflation trading caused the cyclicals to outperform the mega-caps. And it means that stock prices have undergone major corrections as the stock market set new records.
The money hasn’t left the market that much, but has flowed back into the huge balance sheet, cash flow cows in technology that can continue to perform even in a slower economy. This is a sign that investors have become a bit more defensive even within the S&P 500. But it also means that the returns in the S&P 500 can expand if the current carousel of worries does not lead to a sustained negative trend reversal in stock sentiment, known as Lerner.
“Internal rotation is healthy,” he said. “We’d rely a little on a balance between the two. It is not so clear that investors should be exclusively cyclical or growth oriented. … expectations have been severely set back, so a little good news can go a long way. “
The rate of earnings growth is likely to peak soon, and Lerner says the next year will have much more difficult earnings calculations than after a pandemic-induced economic standstill. But peak earnings growth is not the same as peak earnings. “The trajectory is higher,” he said. And instead of trying to pinpoint spike profits, he continues to focus on whether or not the earnings estimate revisions may turn negative, and sees no symptom or pattern in this market.
“When we have earnings growth that is peaking and at a peak in Fed accommodation and we cannot achieve a better fiscal environment, it all indicates that the trend is higher, but with moderation, and that turns into volatility and some bigger wins and opportunities. “Below the surface instead of the headline index.”
That might be a gut check for investors driving the market higher overall, and this is evidence of last week’s sales, but Lerner advises every investor to remember what famous Fidelity Magellan fund manager Peter Lynch once said : “Investors who tried to anticipate corrections have lost far more money than they have lost in the corrections themselves.”