After a three-year hiatus, the Golden State Warriors are the best team in basketball again -- and they had to navigate an injury-driven tumble from the top to the absolute bottom to do it. There's a lesson in there about bear markets, recessions, and all the fears gripping investors right now.
After the stock market's tumble this past week, investors probably feel like Warriors star Stephen Curry in 2020 asking what else could possibly go wrong. The S&P 500 dropped 5.8%, its worst weekly decline since March 2020, while the Dow Jones Industrial Average and the Nasdaq Composite both fell 4.8%.
It was "the worst stretch of selling in the history of the S&P 500," according to Sundial Capital Research's Jason Goepfert, who noted that there were five days since June 8 when more than 90% of the index's stocks finished lower. The question now is how much more can go wrong.
Plenty. The week's drop, which sent the S&P 500 into a bear market, was caused by rising bond yields, some weak economic data, and, of course, the Federal Reserve, which raised interest rates by three-quarters of a point for the first time since 1994.
And there's more where that came from. The Fed, battling inflation unlike any it has seen in the past 40 years, could raise interest rates higher than currently expected -- there's a 89% chance of another three-quarter-point increase in July, although the chances of that happening in September are much lower -- while signs of an economic slowdown emerged this past week as housing starts fell 14% month over month in May and retail sales dipped 0.3%.
"The Fed needs to bring inflation down, and the growth rate of the economy will be a victim," says Dave Donabedian, chief investment officer at CIBC Private Wealth US.
That's scary enough, but the biggest near-term concern for the stock market might be earnings. Right now, they're expected to be quite good, with analysts forecasting 11% growth to $228 per share in 2022, and 9.6% growth to nearly $250 in 2023.
But Wells Fargo strategist Chris Harvey expects companies to sound far more worried on their next conference calls in the kind of abrupt pivot that hasn't occurred since 2007.
"Overall, we think the market has quickly shifted from fears of undersupply to oversupply, and corporate outlooks will shift dramatically as earnings are revealed," explains Harvey, who recommends avoiding "broken stories," stocks that include Walt Disney (ticker: DIS), Etsy $(ETSY)$, Netflix $(NFLX)$, and Boeing $(BA)$.
If he's right, earnings forecasts will have to come down -- and the S&P 500, which trades at 15.4 times 12-month forward earnings, isn't nearly as cheap as it looks. Goldman Sachs' David Kostin notes that if S&P 500 companies earn $239 and trade at 17 times, the index would trade at 4165, up 13% from Friday's close. That's the optimistic case.
But if 2023 earnings come in lower -- say, at $225 -- and the price/earnings ratio slips to 14, the index could trade down to 3150, off 14% from Friday's close. "Investors looking for value opportunities should consider both valuations and potential downside risk to earnings estimates," he writes.
Still, it isn't the end of the world. Jim Stack, president of InvesTech Research, took equity exposure down to 44% this past week, his most defensive portfolio since the tech bubble in 2000. He doesn't sound down about it. Instead, he's looking ahead. "The 'good news' is that this will ultimately lead to one of the best buying opportunities in decades, " he writes. "But for now, patience is paramount."
It may take time, but the market will get that winning feeling once again. Bet on it.
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