Stocks May Be Headed for a Major Skid

Stocks started slipping on Aug. 16, following a two-month rally, as investors began to grasp that the Federal Reserve likely wouldn’t soon pivot away from its interest-rate increases.

After Fed Chairman Jerome Powell made clear in an Aug. 26 speech that indeed the Fed has no intention to back off rate hikes, the S&P 500 has dropped 3.5%. And the descent may have a lot further to go.

Powell said rising rates will probably cause pain for the economy. “This was not the Powell we normally see, where he tries 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 could take what he said any other way.”

The economy already is slowing, with GDP shrinking 0.6% in the second quarter after a 1.6% slide in the first quarter.

An economic slowdown means lower corporate earnings. And if Fed rate hikes push the economy into a recession, earnings could stumble big time.

Earnings Numbers

The blended earnings growth rate for the S&P 500 was 6.7% for the second quarter as of Aug. 5, according to FactSet. The blended rate includes results for companies that already have reported earnings and analysts’ forecasts for those that haven’t.

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That is the lowest increase since the fourth quarter of 2020, when the covid pandemic was raging. And if you take out the soaring energy sector, earnings  decreased 3.7% in the second quarter.

“The path for stocks from here will be determined by earnings, where we still see material downside,” Morgan Stanley strategists wrote in a commentary cited by Bloomberg. “As a result, equity investors should be laser focused on this risk, not the Fed.”

Meanwhile, the S&P 500’s forward price-earnings multiple trailed 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-earnings multiple can point to lower stock prices ahead.

Bearish Wagers

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 drop.

And U.S. stock funds suffered a net outflow of $1.2 billion in the week ended Aug. 24, according to Refinitiv Lipper data, as cited by The Wall Street Journal.

“There’s so much skepticism, so we’re still in the sell-the-rally mentality,” Mark Hackett, chief of investment research for Nationwide, told the paper. “If everybody feels we’re in a bear market rally, it will almost become a self-fulfilling prophecy.”

Seasonal factors don’t bode well for stocks either. August and September are historically the worst months of the year for the S&P 500. The index has averaged dips of 0.6% and 0.7% for those months, respectively, over the past 25 years, according to Bloomberg.

Put it all together and things aren’t looking too bright for stocks.

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