By Jacob Sonenshine
If only the stock market were stuck between jokers and clowns instead of sticky inflation and rising geopolitical tensions. Then the S&P 500 index might not have had such a bad week -- or appear set for another one.
And boy, was it a bad week. The S&P 500 was dropping 3%, on pace for its third consecutive week of declines, while the Dow Jones Industrial Average was dipping 0.3% and the technology-heavy Nasdaq Composite was falling 5.3%.
Worse than the drops themselves, every rally in the S&P 500 was sold during the week, with gains turning to losses by the end of the day. And that makes sense. While the S&P 500 is still up 21% from a late October low, investors now seem to realize that the economic and geopolitical landscapes have turned against them.
It starts with economic data. It's just too darn strong. March retail sales rose a hotter-than-expected 4% year over year, up from February's 2.1% rise, adding to the concerns raised by Jerome Powell and Federal Reserve speakers that the economy is too strong to bring inflation down much more. Data like that would likely delay Fed rate cuts. There's only a 16% chance of a rate cut in June, down from 56% one month ago, according to the CME FedWatch Tool. Those concerns were evident in the spike in the two-year Treasury note, which hit 5% on Thursday, a sign that rates are expected to remain higher for longer.
A more restrictive Fed would remove one tailwind that has helped stocks rally this year. Geopolitics adds a headwind. Between Iran's attack on Israel on April 13 and Israel's response on Thursday, investing almost feels like it requires a degree in game theory rather than finance. The potential for additional flare-ups could also help support oil prices, even if the price of Brent crude futures, the European benchmark, fell 4.7% this past week after hitting $90 following Israel's response. Brent is up 13% for the year, and if it can trade meaningfully higher than $90, oil prices could contribute to inflation.
"Persisting inflation forces raise the risk that rates will need to stay higher for longer than expected," writes J.P. Morgan strategist Marko Kolanovic. "Inflation risks are also compounded by upside risks to oil due to geopolitical developments."
These issues won't resolve themselves overnight. And the longer they last, the more of a problem it will be for a stock market that looks pretty expensive. The S&P 500 is trading at 20 times 12-month forward earnings, well above its average of 16.5 since 2000.
The market's saving grace is that the economy and earnings are holding up. First-quarter gross domestic product, due this coming Friday, is expected to have grown by a very solid 2.9%, according to the Atlanta Fed GDPNow estimate, while S&P 500 earnings are expected to grow by 2%. The market, however, appears to be worrying about the probability of a hit to the economy. The S&P, after all, has dipped below its 50-day moving average. And when it does that, the index often goes on to drop at least another 5%, which happened in 2023 and twice during 2022.
The next major level of buying support, as has often been the case over the decades, is the S&P 500's 200-day moving average at 4671, a 6% drop from current levels. "A 'normal' pullback in a 'normal' non-recession year tests the S&P 500's 200-day moving average," writes Evercore strategist Julian Emanuel.
Some dips should be bought. This one should be feared, at least for now.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 19, 2024 13:36 ET (17:36 GMT)
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