The slump in the stock market could continue while the dollar becomes stronger as Wall Street waits for Fed Chairman Jerome Powell’s speech later this week and as concerns about inflation and a slower economy rise.
U.S. stocks fell sharply to start the week on on Aug. 22 with the S&P 500 down 2.14% and the Nasdaq down 2.55%. Both gold and oil prices also fell. The S&P 500's decline was the largest in two months.
S&P 500 Slumps Again
The market’s four-week winning streak ended last week as investors are becoming more defensive and preparing for less economic growth. The equity market could see deeper losses if the S&P fails to reach above its 200-day moving average, Scott Minerd, global chief investment officer at Guggenheim said in a blog post.
Stocks had rallied since the June Fed meeting and more declines in the market could occur as investors are increasingly pessimistic as the odds of a recession rise.
The current rally “failed to break the downtrend that has been in place since the beginning of the year,” he wrote.
The 200-day moving average is an important indicator to watch because in May 2008 the market rebounded just shy of the average.
Stocks then plummeted with the S&P 500 declining another 53% before reaching a bottom in March 2009, “bringing the peak-to-trough decline to 57%,” Minerd said.
Failure to reach the 200-day moving average was also a critical point during the bear market of 2000–2002.
The two-year period “saw several failed breakout attempts that ultimately resolved in a peak-to-trough decline of 49%,” he said. “Also worth noting is that the downtrend was not broken in either of these episodes.”
Growth Stocks Face Challenging Times
A handful of sectors, energy and defensive stocks such as consumer staples and utilities, are the only ones that maintained gains over their respective 200-day moving averages as of Aug. 19.
Growth stocks face several headwinds even though these sectors led the rebound since June.
They remain “below that key technical threshold, indicating that more problems could lie ahead for growth stocks if the rally is not sustained,” Minerd said.
Waiting On Fed's Next Move
The market is undergoing a “digestion phase, triggered by weaker-than-expected economic reports and anxiety ahead of the statements and policy indications expected to emerge from the Jackson Hole Economic Symposium,” said Sam Stovall, chief investment strategist at CFRA Research.
The Fed’s rate path, part of its strategy to lower inflation, remains complicated. Sentiment that the Fed would hike rates again by 75 basis points in September fell. Investors find themselves on either side of the fence - bets on a 50 basis point move are sitting at 49.5% and the chances of a 75 basis point increase pegged at 50.5% ahead of Powell’s address at the Jackson Hole symposium later this week.
The market is approaching a crossroads, according to Lowry Research, a CFRA business.
Market breadth will “likely be key to the final tipping point in the identification of a new sustainable uptrend,” Stovall said.
“New record highs in Lowry’s market breadth indicators, ideally accompanied by rising volume, would help to confirm a new bull market,” he said. “But a failure at overbought levels, accompanied by evidence of heavy selling, would increase the probabilities of a renewed decline or test of the June low.”
The next several weeks could shed more light for investors on what strategy to adopt for the next two quarters.
“The weeks ahead will determine whether investors are best advised to continue to gradually embrace the advance, which would then be more likely to last many months, or prepare for the next leg of a longer-term decline,” Stovall said.
If a recession occurs, investors should expect earnings estimates to be marked down, Minerd said. "Equity analysts’ earnings per share expectations have already declined slightly since June.
"On a fundamental level, Federal Reserve officials appear determined to bring inflation down by causing a recession," he said. "A cyclical decline in price/earnings ratios will likely combine to take stocks to new lows before this bear market is over."
