Stocks began to slide on August 16, after a two-month rally, as investors began to realize that the Federal Reserve was unlikely to back down on interest rate hikes anytime soon.
After Fed Chairman Jerome Powell made it clear in a speech on Aug. 26 that indeed the Fed has no intention of backing down from raising interest rates, the S&P 500 fell 3.5%. And the descent may still have a long time to go.
Powell said rising interest rates are likely to hurt the economy. “It wasn’t the Powell that we usually see where he’s trying to be more balanced,” Lee Ferridge, head of macro strategy at State Street Global Markets, told The New York Times.
“I don’t see how you can take what he said any other way.”
The economy is already slowing, with GDP contracting 0.6 percent in the second quarter after a 1.6 percent decline in the first quarter.
An economic slowdown means lower corporate earnings. And if the Fed’s interest rate hike pushes the economy toward a recessionearnings may stumble significantly.
The compound earnings growth rate for the S&P 500 was 6.7% for the second quarter through Aug. 5. according to FactSet. The blended rate includes results for companies that have already reported earnings and analyst estimates for those that have not.
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This is the lowest increase since the fourth quarter of 2020, when the covid pandemic was raging. And if you strip out the growing energy sector, revenue fell 3.7% in the second quarter.
“The path for stocks going forward will be driven by earnings, where we still see significant downside,” Morgan Stanley strategists wrote in a note quoted by Bloomberg. “As a result, equity investors should focus on this risk, not the Fed.”
Meanwhile, the S&P 500’s forward price-to-earnings ratio lagged its five-year average but exceeded its 10-year average as of Aug. 5: 17.5 versus 18.6 and 17, according to FactSet. A high price-to-earnings ratio may indicate lower stock prices ahead.
In other negative trends for stocks, many investors are betting against them, with net short positions reaching two-year highs. Short positions are bets that stock prices will fall.
U.S. stock funds saw net outflows of $1.2 billion in the week ended Aug. 24, according to data from Refinitiv Lipper, as quoted by The Wall Street Journal.
“There’s so much skepticism, so we’re still in a rally selling mentality,” Mark Hackett, head of investment research for Nationwide, told the paper. “If everyone feels like we’re in a bear market rally, it’s almost going to become a self-fulfilling prophecy.”
Seasonal factors are also not good for stocks. August and September are historically the worst months of the year for the S&P 500. The index has averaged declines of 0.6 percent and 0.7 percent, respectively, for those months over the past 25 years, according to Bloomberg.
Put it all together, and things aren’t looking too bright for the stock.