The Stock Market Drop Seems Over. How It Could Still Tumble 10%.
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*** ONE-TIME USE *** Traders during the listing of WeWork on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Thursday, Oct. 21, 2021.
Michael Nagle/Bloomberg
The stock market may have rebounded quickly from its slump, but slower economic growth and the Federal Reserve hiking interest rates could cause a more extreme correction.
The S&P 500 has risen 5.8% since Oct. 4, when the index hit bottom from a decline that began in early September. The market had averted a correction, technically defined as a 10% drop from a recent peak. Better-than-expected earnings and retail traders racing to buy the dip have driven the recovery. A breadth of stocks have participated in the rally, indicating markets are optimistic about the economic earnings outlook.
But a real correction could still be coming, and it will be a shock to investors. Everyone goes into the boxing ring “with a plan” to buy-the-dip until they get hit with a double-digit correction,” writes Barry Bannister, chief equity strategist at Stifel.
Something has to cause that correction, and one possibility may be plain old slower economic growth. The Institute For Supply Chain Management’s Purchasing Managers Index, a broad measure of economic activity, grew at its fastest pace in decades— almost 50% year-over-year—in early 2021. That growth has recently slowed to less than 25%. Stifel’s forecast shows it could actually decline year-over-year by December. The S&P 500’s movements are tightly correlated to those of the Purchasing Managers Index, and Stifel’s analysis shows that the index would fall below 4000 in that scenario. That could be a more than 13% drop from the index’s current level.
While economic growth is slowing, the Federal Reserve may still have to raise interest rates to keep inflation in check, a dynamic that could easily cause a correction. High inflation has recently persisted as companies are having trouble acquiring the supplies to meet demand.
Inflation aside, the Fed may want to raise rates to avoid a stock market bubble, Bannister says. The S&P 500 has more than doubled from its bear market bottom, which it hit during the worst of the pandemic in March 2020. A rate hike soon could also spur a more than 13% decline for the S&P 500, Stifel’s analysis shows. “The Fed knows it is in their own best interest to continue tightening policy to avoid a bubble,” Bannister writes.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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