By The recent performance of the stock market has been quite shaky. Several factors could potentially contribute to a significant drop in the market.
Record Highs Prove Elusive
The S&P 500, currently hovering just above 4700, has been struggling to reclaim its record closing high of 4796. This milestone was initially reached in early January of 2022. Despite approaching it three times in the past month, the index has been met with selling pressure each time, pushing it lower. As a result, it has started the new year with a nearly 1% decline.
The Search for a Catalyst
The market seems to be in search of a true “catalyst” or event that could potentially push it significantly lower. Although it briefly dipped below 4700 a few times last week, buyers stepped in to send it higher again. Nonetheless, the market is clearly facing challenges in sustaining a rally.
The Expensive Market Reality
This lack of sustainability should come as no surprise given the market’s already lofty valuation. The S&P 500 is currently trading at a multiple of 19 times the aggregate expected earnings per share analysts anticipate for the next 12 months. This valuation is one of the highest multiples the index has reached since the Federal Reserve started raising interest rates in early 2022 to curb economic demand. Historically, higher interest rates have made equities less attractive, resulting in decreased buying interest for the index at its current elevated multiple.
Potential Catalysts Lurk
There are a few looming catalysts that could potentially push the market lower.
Disappointing Profit Guidance
One such risk is disappointing profit guidance. The concern lies in the strength of sales, as demand for goods and services tends to weaken with a delay after interest rates rise. Given the strong rate of economic growth in recent quarters, it is expected that growth will only weaken from here. Companies are likely to issue conservative guidance, especially if they observe a decline in top-line trends in the final few weeks of the fourth quarter. Investors should keep an eye out for quarterly reports starting with releases from Wells Fargo, JPMorgan Chase & Co., and Bank of America on Friday.
Introduction
Market analysts are cautious about the full-year 2024 outlook, predicting it to have a negative impact in the near term. According to Wells Fargo’s chief U.S. equity strategist Chris Harvey, the provided guidance has been underwhelming. This sentiment is echoed by the fact that certain areas of the economy have already started to display signs of weakness. As a result, profit forecasts may need to be adjusted downward.
Manufacturing Activity and Earnings
The Institute for Supply Management’s manufacturing purchasing manager’s index (PMI) has depicted a downward trend, currently hovering just below 50. This figure is a significant drop from the level of 55 observed before the Federal Reserve implemented rate hikes. Bank of America reports that, historically, the current PMI level translates to S&P 500 earnings per share (EPS) for this year being approximately 10% lower than the aggregate forecast provided by analysts covering index companies.
Impact of Rate Cuts
Another factor that could potentially drag down stock prices is a discrepancy between market expectations and actual Federal Reserve rate cuts. The federal funds futures market indicates that investors anticipate multiple rate cuts throughout the year, as disclosed by the CME Group. These expectations emerged in response to declining inflation rates last year, stimulating a double-digit increase in the S&P 500 in 2023. However, if these projections are not met, there is a strong possibility that stock markets will descend. With inflation still slightly above the Fed’s target of 2%, it is likely that markets will reassess and lower their rate cut expectations.
Time to Wait and Observe
Considering the current conditions, it would be prudent to hold off on purchasing stocks. Instead, it may be more advantageous to wait for an opportune moment when prices have experienced a decline.
In conclusion, the stock market outlook appears uncertain at present. Analysts advise adopting a cautious approach and monitoring the situation closely before making any investment decisions.
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