Stock Market Analysis Today – Stock Market Correction Worries Are Overblown. Here’s Why.
The market’s mind has been intensely one-tracked since its early-pandemic nadir. In the background, beyond the skyline of stocks pushed higher and higher by the Federal Reserve’s very visible hand, a storm is brewing.
The question is whether it matters.
This time of year is usually fraught for the stock market, and this year it has been especially so. The
is already down more than its historical September average. In the context of year-to-date performance, though, September’s decline has barely been a blip, and the U.S. stock market looks unshakable. The flood of liquidity from the Fed and U.S. Treasury has left a lot of people with more money than they know what to do with, and thus U.S. stocks have had nowhere to go but up.
That’s true, of course, until the moment it isn’t. Many strategists say it’s a matter of when, not if, the stock market corrects. It has doubled since bottoming on March 23, 2020, without a single decline in excess of 10%. They say correction is due because the party has gone on too long and the list of could-be and should-be triggers is too daunting.
“The issue is that the markets are priced for perfection and vulnerable,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. She predicts a 10% to 15% pullback before the end of the year but ultimately sees the economic cycle and bull market remaining intact.
Covid-19 hospitalizations are rising, and consumer confidence is plummeting. Geopolitical risk is building after the U.S. departure from Afghanistan and China’s regulatory crackdown. price inflation isn’t relenting. The latest debt-ceiling fight will probably go to the 11th hour, raising the specter of default or a rating downgrade.
Most importantly, fiscal and monetary policy are on track to tighten concurrently, just as economic growth slows sooner and faster than predicted. Tax increases are coming, and fiscal stimulus is fading, while chances are rising that the Fed will this year start reducing the monthly bond purchases it started to support the economy early in the pandemic.
The problem with the correction narrative is that none of this is new. Call it information overload, apathy, or calculated dismissal. Whatever it is, investors aren’t blind; they just haven’t seemed to care. That alone is reason to question the growing warnings. Why now?
There is one reason that investors have been able to tune out the alarm bells, and it’s a good one. Fed Chairman Jerome Powell has succeeded so far in assuring markets that inflation won’t be enduring, tapering isn’t tightening, and the easy-money punch bowl isn’t going away. When the world is viewed through one lens, bad news is counterintuitively good and the rest discarded. That money will remain extremely easy is all that has mattered. “Asset bubbles and financial stability concerns be damned,” says Shalett.
Over the next few months, bears have their best shot in a while of challenging that construct. For a fresh set of potential correction triggers, they are looking 200 miles or so from Wall Street, down Interstate 95, to Capitol Hill.
“We have a policy pileup coming,” says Barry Knapp, managing partner at Ironsides Macroeconomics, where monetary and fiscal policy are about to tighten simultaneously. “The first policy tightening might come from the Fed, but it might not,” Knapp says. “Market participants ignore fiscal policy until it’s clear that ‘holy cow, they’re actually doing this.’ ”
Lawmakers have been jostling for months over President Joe Biden’s $3.5 trillion spending proposal—the capstone of his economic agenda and a sweeping plan to significantly expand the nation’s social safety net, cut carbon emissions, and raise taxes on corporations and some households. That “soft” infrastructure bill follows roughly $5 trillion in fiscal spending in response to the pandemic, and it is apart from the $1 trillion “hard” infrastructure package that has already secured bipartisan support in the Senate.
“If we get a surprise here, I think we get a melt-up instead of a meltdown.”
The final figure for Biden’s budget seems likely to shrink, thanks to leverage that moderate Democrats have over the reconciliation process being used to pass the measure. But it doesn’t much matter, Knapp says, if the reconciliation bill shrinks from $3.5 trillion to something closer to $2 trillion, as many policy analysts predict. Long-term economic implications notwithstanding, the tax increases required to pay for the new spending pose more immediate threats to the economy and market.
“From the perspective of equity investors, this is not fiscal stimulus. It’s fiscal tightening,” says Knapp. He sees a 10% to 12% correction in the offing, based on the confluence of factors.
But already, tax increases are shaping up to be less aggressive than investors had feared. Proposals from the Democratic-led House Ways and Means Committee include an increase in the tax on long-term capital gains and dividends, to 25% from 20% for individuals earning over $400,000 and married couples making more than $450,000. Some policy analysts had expected an increase in that rate to 28%. (Both the 25% proposed rate and the 28% expected rate are before a 3.8% surcharge on investment income.)
Meanwhile, the top rate on ordinary income for upper brackets would revert to the 39.6% from the 37% rate set in the Tax Cut and Jobs Act of 2017, with people making over $5 million a year hit with an added 3% surtax on income as well as on capital gains and dividends. That, too, is still less than what the Biden plan proposed. Some of the biggest floated changes, including the elimination of the step-up in cost basis for estates, were left on the cutting board.
“The committee’s proposal is a less radical approach to tax policy,” says Brian Gardner, chief Washington policy strategist at Stifel, mostly sticking within the current framework of the tax code rather than overhauling it.
That’s not to fully dismiss the impact of tax changes. Under the Ways and Means Committee proposal, the top corporate income-tax rate would rise to 26.5% from 21%. Sen. Joe Manchin (D., W.Va.), however, has said 25% is his top number, and so it’s reasonable to expect that is where it settles. Democrats are also seeking to increase taxes of foreign profits of U.S. firms, a particular pain point for investors, given the potential impact on some of the market’s highest fliers.
But Gardner says the proposal seems to be more limited than the Biden administration’s proposal for a global minimum tax, which critics say would put the U.S. at a competitive disadvantage.
As lawmakers haggle over spending and tax plans ahead of House Speaker Nancy Pelosi’s (D., Calif.) Sept. 27 infrastructure vote, there’s a separate clock ticking. Earlier this month, Treasury Secretary Janet Yellen said the U.S. could default on the national debt as soon as October unless Congress lifts the federal borrowing limit, which was reinstated on Aug. 1 after a pandemic suspension.
“The risks of a default are higher than at any time since 2011,” say analysts at Cornerstone Macro, when the debt-ceiling crisis resulted in a downgrade of the U.S. credit rating.
Still, investors are right to look beyond the bluster. The U.S. isn’t going to default. Knapp at Ironsides says past debt-ceiling scares have resulted in 4% drops in the S&P 500 index, though those falls have quickly reversed. When the 11th hour inevitably hits, it will present a buying opportunity.
There are other land mines in Washington. It is no guarantee that Biden will keep Powell as Fed chairman when his term expires in February. Progressives are clamoring for a new top central banker, though strategists say Powell is likely to keep his job. Before that, the expiration of Fed governor Randal Quarles’ term in October gives progressives a chance to potentially install a more aggressive bank supervisor. Sen. Elizabeth Warren (D., Mass.), a member of the Senate Banking Committee, has been particularly vocal about replacing Quarles.
From taxes to the debt ceiling and a potential Fed shake-up, strategists in Washington, like analysts across Wall Street, are perplexed by investors’ cool. “All of these things are swirling together, and every day it’s like a flashing strobe light of new market risk,”says Frank Kelly, managing partner at Fulcrum Macro Advisors.
Cutting through the noise and flashing lights, there is one number that sums up where markets are and where they go from here. Global central banks are buying about $300 billion in assets a month, notes Torsten Sløk, chief economist at
Apollo Global Management
“There are a lot of things going on. But at the end of the day, this is the key.”
Together, the assets of the Fed, European Central Bank, and
Bank of Japan
have surged to a record-high $24.5 trillion at the end of August from $16.2 trillion before the pandemic, says Ed Yardeni, president of Yardeni Research. The yearly growth rate of those aggregate assets has fallen from a peak of 58% in February to 17% at the end of August, but that pace is still relatively high, Yardeni says.
More important: While the sum of the central banks’ assets may grow more slowly from here, it isn’t likely to fall soon. Even when the Fed does begin to reduce monthly purchases, Yardeni says that any tantrum will be brief. Potentially lessening the blow is Powell’s effort to stress that this time, tapering doesn’t signal that the clock has started for interest-rate liftoff.
“If we get a surprise here, I think we get a melt-up instead of a meltdown,” says Yardeni.
That brings us back to where we started. The everything-rally was created by the Fed, and it’s the Fed’s to take away. Valuations look stretched only if interest rates are going to normalize in the next couple of years, says Sløk, meaning that investors may be calling the bluff on the Fed’s desire and ability to meaningfully lift rates from zero.
That’s a risky bet, given the inflation picture. Consumer price inflation might have cooled a touch in August, but the Fed has already steered investors away from hard metrics like the consumer price index and toward softer ones like inflation expectations. The New York Fed itself recently said that three-year inflation expectations rose to 4%, a record high that is double the Fed’s target rate. The development suggests that consumers expect inflation to stick around, thus making it more likely it does.
Companies like paint maker
(ticker: SHW), which recently cut third-quarter sales guidance, are meanwhile warning of margin pressure as input prices keep rising, prompting analysts to cut S&P 500 earnings forecasts for the quarter. As inflation remains elevated, strategists say the Fed will indeed raise rates—if not soon.
Therein lies the silver lining for a market intent on interpreting bad news as good. If the market does ultimately correct in anticipation of tighter monetary policy, the Fed will pause or at the very least slow its efforts. Because the so-called wealth effect is an important part of monetary policy—consumers spend more as their assets grow—central bankers don’t have much tolerance for market downturns. “If the market corrects, the Fed steps in and helps the market all over again,” Sløk says.
Investors should pay attention to the panoply of risks coming from Washington and beyond because market downturns create buying opportunities. The Fed put is real, and at least for now, it looks to be in the money.
Write to Lisa Beilfuss at [email protected]
Tag: Stock Market
Stock Market Analysis Today – Stock Market Correction Worries Are Overblown. Here’s Why.