S&P 500 may see another 8-10% fall before it matches with its longer term up trend

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Retail US market investors have been buying the dip since the days the market turned bearish and stock prices began to fall. For a long term investor in top US stocks, this perhaps could be the right approach as buy low, sell high remains a robust principle to create wealth over a longer time frame. Currently, the markets are sliding and more downside could be witnessed.

Soumyo Sarkar, Ex-Wall Street Manager and Financial Advisory Council Member of Fintso, who has a pulse on the US Stock market shares his views with FE Online on the current situation. Read on to know his views on why the market is falling and by when there are chances for a long term upmove.

There has been a significant selloff in the US stock markets this year. It has been the worst start to a year in nearly a century. As of May 10th, the S&P 500 index is down 16% year to date, while the tech heavy Nasdaq is down 25%. Smaller cap growth stocks have performed far worse.

But this dramatic fall needs to be put in context of returns achieved over the last 5 years or longer. Even with this selloff, the S&P 500 has returned 82% and the Nasdaq 126% in the last 5 years. Comparatively, Vanguard Europe index has returned 18%, MSCI Emerging markets index has returned 8%, while MSCI India index has returned 40% (all returns are in USD).

The key reasons for this selloff are inflation numbers currently at a 40-year high and the US Fed’s aggressive monetary tightening and balance sheet reduction plans going forward. There are fears that a recession is coming, or worse, stagflation, brought about by inflation numbers that refuse to subside even when the economy slows down. Ukraine war uncertainties and sharp slowdown fears out of China (the other big engine of global growth) are further adding to investor’s angst.

So, how long will the retail investors take to recover from the current US fall?

To answer this question, we need to first answer if we are at or near the bottom of this selloff wave. From a technical perspective it would appear that we have more to go. S&P 500 index needs to sell off another 8-10% more before it matches its longer term up trend.

A similar conclusion is derived if one were to look at other technical parameters such as the percentage of stocks trading above their 200-day MA compared to previous market bottoms.

In our view, a better answer is derived by looking at the negative factors that have caused this selloff and determining whether there are signs they are abating. Here there some reasons to be more optimistic:

-The Fed dot plot (a summary of future rate raise expectations) is indicating that the Fed funds rate will be raised to around 2.5% through a series of half and quarter point raises in 2022 / 2023. This is considered a neutral rate which is neither stimulatory or restrictive. After this the Fed will pause and look at the state of the economy and inflation to decide what needs to be done next. It is our belief that by end of 2022 or sooner, inflation will be contained, as supply chain issues get unsnarled. The Fed would, thereafter, be in an extended holding pattern. This would be interpreted positively by the markets.

  • Recent economic data as well as corporate earnings reports point to low likelihood that the US economy will be in a recession any time soon. Furthermore, much of the overvaluation in the markets have already been wrung out – the S&P 500 12-month forward PE is already at the lowest point since April 2020.
  • Recent China news indicates that the current Covid wave has been contained
  • There are indications that some sort of ceasefire or limited armistice may happen in Ukraine over the next several months
    The S&P 500 will need to rise around 20% from here to make up for the current fall. We expect a slow and bumpy recovery from here and expect the shortfall to be made up in 1.5 to 2-year time frame.