UPDATE: Is the worst really over for US stocks?

Last month, we posed the question: “Is the worst over for US stocks?”

Answer: apparently not.

 

 

A week after that August 10th article, the S&P 500 did climb higher, only to be resisted by its 200-day simple moving average.

The blue-chip stock index even closed above the 50% Fibonacci retracement level, which was the key event for suggesting that the worst is over for the 2022 rout in US stocks.

As cited in the August article, according to data by the CFRA and S&P Global, in 18 of the 19 ‘bear markets’ seen since World War II, the S&P 500 then went on to a fresh bull run after closing above its 50% Fib retracement line.

But as the saying goes across financial markets: “Past performance is no guarantee of future results.”

And that track record (stated above) now needs to be updated to “18 out of the past 20 bear markets …”.

Since that August article, the S&P 500 has unwound all of its summer gains, even printing intraday prices not seen since end-November 2020.

In essence, we have seen “worse” levels this week for the S&P 500 compared to those June lows.

 

Why did the S&P 500 erase its summer gains?

Recall the premise for the S&P 500’s summer rally, as stated in last month’s article:

“Arguably, the primary reason is that markets believe that the Fed has done the largest chunks of its rate hikes already.”

Additionally, the S&P 500’s summer gains was based on the idea of a “dovish pivot” by the Fed.

That’s to say that markets had expected the Fed to be less courageous about sending US interest rates higher, for fear of triggering an economic recession.

But now we know better.

Since then, we have seen the US inflation data stubbornly printing near its highest levels in around 40 years.

Hence, many Fed officials, including Fed Chair Jerome Powell himself, have since sent a strong message to the markets:

The US central bank is hell bent on taming multi-decade high inflation by sending US interest rates even higher, and is willing to tolerate economic pain along the way.

 

Markets duly paid heed and raised their forecasted peak for this ongoing Fed rate hike cycle by about 90 basis points!

• Back in August, markets expected that US rates won’t go higher than 3.6% in March 2023.
   
• Today, that forecasted peak is now expected to reach nearly 4.5% by March.

 

What do higher US interest rates mean for the US economy?

Essentially, the Fed wants to see some “demand destruction”.

Policymakers want to see less money in an economy chasing after scarce goods and services.

That should, in theory, discourage businesses from ramping up their selling prices, hopefully resulting in slower inflation.

However, more economic pain could also bring about a shrinking economy i.e. a recession.

 

What do higher US interest rates mean for US stocks?

More downside likely.

With the US unemployment rate forecasted by the Fed to rise to 4.4% by end-2023, significantly higher from the 3.7% figure from last month, more jobless Americans should translate into less demand/spending in the US economy, which should also mean less earnings for companies.

Lower earnings due to such “economic pain” should also lead to lower share prices, with such a narrative already dragging on the S&P 500.

 

Tech not spared

Also, higher interest rates mean its tougher for so-called “growth companies” to continue borrowing cheap loans to fund its expansion plans while forsaking profitability.

Hence, as higher interest rates chock some of the potential growth (and earnings potential) for these growth companies, that has led to lower stock valuations as well.

Keep in mind that, with many of these growth stocks concentrated in the tech sector, no surprise then that the tech-heavy Nasdaq 100 has a year-to-date decline of almost 30%, falling deeper than the S&P 500’s 22% year-to-date decline.

However, the Nasdaq 100 is still managing to not surpass its June lows … for now.

Also, note that tech-led declines would only exert more downward pressure on the S&P 500.

This is because IT stocks (think Apple, Microsoft, Nvidia, etc.) account for over a quarter (26.6%) of the S&P 500.

So, if you couple the S&P 500’s exposure to tech stocks with the weightage of consumer discretionary stocks (e.g. Amazon, Tesla, McDonald’s, etc. - which tend to take an earnings hit when customers have less disposable income during times of economic pain), then a US recession that’s triggered by higher US rates would only exert more downward pressure on the S&P 500.

 

NOTE: The S&P 500 index is widely used as the benchmark to gauge how overall US stocks are performing.

 

So where to next for the S&P 500?

Brace for the low-3000s.

In market fears surrounding a US recession continue ramping up, that may send the S&P 500 to as low as:

• 3400: around the pre-pandemic peak set in Feb 2020
  If so, this would mark another 7% drop from current levels, also translating into a 29.5% drop from its all-time intraday high.

or even ... 

• 3200: double-bottom from Sept/Oct 2020
  If so, this would mark another 13% drop from current levels, also translating into a 33.6% drop from its all-time intraday high.

 

Though for more immediate consideration, the S&P 500 is testing a crucial support level – its 200-week simple moving average.

This technical indicator has supported the S&P 500 in recent years: 2011, 2016, and most recently at end-2018.

 

Athough the Fed was also busy raising interest rates back in 2018, those benchmark rates today have already surpassed those levels and are now standing at its highest since 2008 at 3.25%.

And US inflation is still around its highest levels since the early 1980s.

So if this 200-week SMA doesn't hold, the S&P 500 is expected to then set course for the low-3000 region, dragged down by heightened  fears over a potential US recession and higher-for-longer US interest rates.

 

S&P 500 Fed rate hikes Recession inflation Nasdaq 100