The stock market has been in a state of inertia for over a month, and it appears that this stagnation is about to change. However, investors might not be pleased with the new direction—the market is likely to move downwards.
A Frustrating Period
For those who are impatient or easily bored, the past six weeks have been nothing short of frustrating. Since July 13, the S&P 500 has been trading in a narrow range, fluctuating between 4510 and approximately 4500. Although it briefly touched higher and lower points during this period, it ultimately settled at this sweet spot. For instance, on July 27, the index reached 4607 before dropping to 4370 on August 17.
Tech Stocks on the Verge
While most stocks are stuck in a range, tech stocks are poised to break out to new highs. The rapid advancement of artificial intelligence is driving higher profit growth in this sector.
To eliminate the influence of Big Tech, the Invesco S&P 500 Equal Weight Exchange-Traded Fund (RSP) equally weights each stock in the index and is currently priced at $150. Its value has remained flat since early July, firmly positioned within the $146-to-$155 range.
Various Factors at Play
The market’s idle state can be interpreted in two ways. Some may be disappointed by its lack of progress. However, considering the numerous challenges both domestically and internationally, the situation is more complex.
Firstly, the Federal Reserve has raised short-term interest rates 11 times within the past 18 months. Chairman Jerome Powell has repeatedly emphasized that the central bank intends to maintain higher rates until inflation is brought under control.
Additionally, the Chinese economy continues to face difficulties even after lifting its zero-Covid policy in December. Both exports and imports have decreased, unemployment rates are soaring, major property developers are facing instability, the yuan is depreciating, and Beijing remains uncertain about implementing stimulus measures.
Economic Stumbling Blocks and the Threat to Corporate Profits
The current economic challenges pose a significant risk to corporate profitability. Lower profits would have a negative impact on an already expensive market. At its peak, the S&P 500 reached 4600, trading at around 20 times the aggregate earnings per-share estimates for the next year. This was a substantial increase from just above 16 times at the beginning of the year. The surge in valuation reflected optimism about earnings, but any weakness in the global economy could lead to a decline in estimates, subsequently affecting the overall market.
However, it’s crucial to recognize that these economic concerns are likely to persist for some time. The market wouldn’t become any more affordable even if it continues to rise, which increases the possibility of a market sell-off.
If the S&P 500 index falls below approximately 4300, the next key support level to watch out for is 4200. Earlier this year, it finally surpassed the 4200 mark when buyers rushed in. Nevertheless, if the outlook for China does not significantly improve or if the U.S. economy weakens due to delayed repercussions from higher interest rates, the index could potentially reach that level again. This would result in a roughly 7% drop from its current position.
Wall Street is concerned about the following scenario: as inflation is reined in by the Federal Reserve, there is a possibility that the economy could be pushed into a recession. This could lead to a loss of forward momentum and an increase in worries about a hard landing between now and the end of the year, as described by Sevens Report’s Tom Essaye.
Given this backdrop, what should one do? For those considering long-term investments, it may be prudent to wait for a significant market downturn before making any substantial purchases.
