Even though the stock market is back in bull-market territory, don’t forget this: Several factors could easily send it down.
Above 4300, the S&P 500 is now up nearly 20% from 3577, the lowest close in the recent bear market. That level, which was reached in early October, left the stock down 25% from a record high hit in early 2022.
The 20% gain on the low technically marks the start of a new bull run, which coincides with a recent surge of optimism. A Baron’s This past weekend’s cover story explains the gains and argues that more may follow.
In the first place, the Federal Reserve has almost stopped raising interest rates because both inflation and economic growth have slowed. Higher rates weigh on demand for goods and services, with an unpleasant effect on corporate profits, so investors are now looking forward to stabilizing economic growth and improving earnings next year. This spring’s mini-crisis in banking has fizzled out, and Congress raised the limit on government debt to avoid a default that would ravage the global economy.
But many negative forces have not gone away. They threaten to put the brakes on the stock market.
The first factor relates to tight monetary policy. According to the Bear Traps report, so-called broad liquidity – the combined size of the balance sheets of the Federal Reserve, the European Central Bank and the Bank of Japan, as well as funds made available through the People’s Bank of China’s liquidity operations – is down since the beginning of last year. down from about $25 trillion to $22 trillion.
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The S&P 500 rises when liquidity increases, falls when it decreases. Given where liquidity is now, the S&P 500 should theoretically end at 3,400, a decline of about 20% from here, according to Bear Traps, a research center that issues an investment newsletter. Low liquidity not only means less money available to invest in stocks, it also means less cash available for banks to lend and spend to consumers. This hurts corporate profits.
It should come as no surprise that a drop in liquidity can bring down the stock market. Some of Wall Street’s biggest bears have expressed related concerns recently. Mike Wilson, strategist at Morgan Stanley, has said that the tightening monetary action works with a lag, which means the Fed’s 10 rate hike from March 2022 could have negative effects in the coming months.
Wilson has said surveys show banks are tightening their belts on lending, a change that ultimately stands to make less money available to both businesses and consumers. The prospect of spending cuts should cause Wall Street’s S&P 500 earnings per share to decline by about 16%, he argues, adding that the index could fall to 3,700.
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Concern is also visible in the credit market, a dynamic not usually found at the start of a bull run. The average yield on 10-year triple-B bonds is higher than the recent 3.7% yield on 10-year Treasury debt at about 1.87 percent, compared with about 1.6 percent a few months ago. The widening spreads indicate growing doubts about the profit outlook and greater concern that companies will not be able to service their debt.
This usually does not happen at the beginning of a bull market. According to BTIG, these are usually triggered by a narrowing of credit spreads, not a widening.
All of this raises the possibility that the bear market that began early last year is still with us. And it indicates that even if an enduring bull market has begun, it makes sense to expect some sort of pullback, even if it is mild.
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The silver lining is that it is also worth buying stocks for long-term investors when the market is weak. There may be an opportunity on the way.
Write to Jacob Sonenshine at [email protected]
Source: www.barrons.com
