The continued volatility in the stock market has been nerve-racking...
In our last few market updates we have said, "it would not be surprising if the U.S. stock market had a correction (a drop of 5-10%) as corrections are healthy for bull markets. They allow the market to reset and “catch up with itself” for the bull’s next leg up. We should prepare for a rocky road ahead but also stay focused on what may come after a potential temporary setback."
We have not had a 10% correction since the rally started in March 2020… so it has been overdue. We do not have a crystal ball, but it looks as thoMugh this may have started the last couple of weeks.
As of earlier today, the NASDAQ has corrected 12% which is a normal healthy correction and it was the most inflated. We may have the same type of correction in the S&P (only down -5.3%) and the Dow (only down -3.63%).
There may also be a sector rotation with the sectors favoring more small companies, mid-size companies, cyclical, and value stocks. Even large companies with higher-yielding stocks may become more attractive. Therefore, we may be making some sector adjustments but we are not concerned that we will have a bigger market pullback at this point.
As the Fed raises rates and tightens, it is always challenging for the stock market. The early bull-market days of a lot of liquidity and Fed support are over, and greater volatility is likely to continue. The stock market is concerned that the Fed will over-tighten and will prematurely end the economic recovery and bring about a bear market. This is a valid concern but we think it is overdone right now.
Why? Because the stock market has frequently continued to provide solid returns during periods when the Fed is raising interest rates. That is particularly true provided that real Corporate Earnings (EPS) rise. Fourth-quarter U.S. real-GDP growth probably came in near 6%, suggesting another solid earnings quarter to come, and that should at least help ease current investor jitters.
So, the question for investors is: Can company earnings prove strong enough to withstand—and even overcome—the Fed raising interest rates?
At present, a consensus expects S&P 500 real-EPS growth of about 10% in 2022. At the same time, although inflation is expected to stay elevated, a consensus anticipates the annual pace of consumer price inflation to ease to 4.5% for the year and moderate to 2.8% YOY by the end of 2022. If this is accurate, that suggests that S&P 500 real EPS are poised for another big annual gain.
So whether a correction is happening now or later this year, it will probably be met by solid company earnings and fundamentals. Any near-term Fed actions are scary, they have ultimately been no match for rising real earnings.
It is our job to rise above the 'noise' and decipher appropriate logical strategies. We are here to help navigate the ups and downs. A major component of that is weighing out the potential risk/reward benefits for each individual client, which we will of course continue to do.
As always, we will continue to let the market tell us what it wants to do. If it shifts course, we will let you know as soon as we see it.
Please reach out if you have any questions.