By Paul R. La Monica
Stocks are bouncing back Thursday following a brutal selloff. But it's time for an unpopular truth about the market: Wall Street is overdue for an even bigger pullback.
The S&P 500, despite its nearly 3% drop on Wednesday after the Federal Reserve spooked the market with its updated outlook on inflation and interest rate cuts for 2025, was down just 3.6% from its highest closing level on record, hit just a few weeks ago. That doesn't include Thursday's intraday rebound and isn't even halfway to the 10% pullback that would result in a market correction.
Before Wednesday's stock market hiccup, the S&P 500 had gained 4.6% since Election Day. That has lifted valuations to somewhat frothy levels. The S&P 500 is trading at 21.5 times earnings estimates for next year, above its five-year average forward price-to-earnings ratio and not far from its January 2021 peak of above 23.
What's more, the S&P 500 hasn't experienced a correction in more than a year. The last 10% slide took place in October 2023, according to Dow Jones Market Data. The S&P 500 is now hovering around 5,900. It would have to tumble to 5,481 to be in correction territory.
Will the market fall that low? That remains to be seen. But experts say a correction isn't necessarily something to dread. Many strategists are still predicting solid earnings growth for 2025. With that backdrop, stocks should head higher, even if there are some bumps in the road.
"A correction is likely. But there are still a couple of years left in this bull market," said John Bartleman, president and CEO of TradeStation, an online brokerage firm.
Corrections can be healthy and even necessary for bull markets. They help shake out some of the so-called froth in the stock market, where prices run up too dramatically and get ahead of themselves. It's hard to deny that investors may have gotten just a little bit too exuberant in the wake of the Republican sweep.
"We're overdue for a correction," said Nancy Curtin, chief investment officer at AlTi Tiedemann Global, a wealth management firm. She says that it wouldn't be the worst thing in the world for investors to be "spooked" for a bit, adding that any correction "would be a buying opportunity."
Plus, a correction doesn't have to lead to a bear market, a 20% decline from a recent high. For that to happen, there probably would need to be a much bigger shock to the economy that would cause companies to start drastically cutting back their profit outlooks. A slightly more hawkish Fed than expected doesn't seem to qualify as a seismic event.
"Investors were pricing in five to six rate cuts coming into 2024. By May, that expectation dipped toward zero cuts, and yet the S&P 500 has continued to storm higher, hitting record highs in 10 of this year's 12 months," said Bret Kenwell, U.S. investment analyst with eToro.
"Mild inflation is good for equities as an asset class, while earnings and the economy continue to act as tailwinds into 2025. Any meaningful correction in US equities is likely an opportunity for investors," he added.
To that end, analysts are currently forecasting a nearly 15% annual increase in profits for the S&P 500 next year and another 13% jump in 2026.
"The U.S. is clearly the MVP of the global economy," said Lule Demmissie, an analyst with Apex Fintech Solutions, an investment advisory and clearing firm. "This is a healthy pullback. If the U.S. wasn't so strong, that would be a problem."
She added that despite recent volatility, many investors, particularly younger ones, remain interested in leading tech stocks in the Magnificent Seven as well as Broadcom, the chip maker that recently surpassed the $1 trillion market capitalization threshold.
"We're not seeing skittishness," Demmissie said.
It's also worth remembering that it was just a few months ago when the market experienced a similar bout of volatility partly inspired by the Fed as well.
Stocks plummeted in late July and early August on worries the Fed hadn't begun to cut interest rates. Weaker economic data and turmoil in Japan and other international markets added to the fears.
The S&P 500 got close to a correction back then, falling about 9.5% from its recent peak, while the Nasdaq Composite actually tumbled more than 10% from its high.
Needless to say, the jitters were short-lived. Stocks were off to the races again once the Fed cut rates in September. That rally continued up until the December selloff.
At least for now, there are no reasons for stocks to not keep climbing to new highs. Just remember: The path higher isn't always a straight line.
Write to Paul R. La Monica at paul.lamonica@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
December 19, 2024 11:43 ET (16:43 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
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