The new chatter on Wall Street is that a stock market correction worse than the pandemic is brewing for the S&P 500. Whether or not that happens, this is a growing fear and one that will impact the market. As for depth, if you’ll think back, the S&P 500 corrected nearly 35% in a matter of weeks back in 2020, and we don’t think that target is unreasonable now.
The cause, the visible cause, is the war in Ukraine and the fallout from it, but fundamentally the reason why stocks fell then and why they will fall now is the same. The outlook for earnings is about to get re-valuated in a systemic way that can only mean one thing, stocks are incredibly overvalued and need a correction. The question is how far they will fall? In our view, the market is inflated on stimulus money and unfulfilled expectations and could easily return to the long-term trend line way down near 2,700.
The S&P 500 Leave Russia, Oil Drives Inflation
A growing number of S&P 500 companies are leaving Russia or shuttering their business. Russia is not an incredibly large economy but is tenth globally in terms of GDP and no small part of many S&P 500 businesses. The takeaway here is the outlook for earnings growth in Q1 and FY 2022 was tepid and beginning to decline before the war started and will surely gain momentum now. We know that a decline in earnings outlook will drive the market lower, and the risk here is considerable. Not only is the outlook for Q1 and the FY in decline, but the consensus estimates also aren’t that high and could easily fall below 0%. In that scenario, the word “recession” comes into play, which isn’t a good thing for the market either.
The earnings outlook was in decline because of inflation, and inflation is hot, very hot. The CPI for February was released, and it came in hot in both the headline and core readings as well as in both the month to month and YOY comparisons. At 7.9% and 6.4%, these are the highest readings in 30 years and not the end of the increases if the forecasts by S&P 500 companies are believed. The chatter in that regard is that wages will rise 15% in 2022, and then there are oil and gas prices to consider.
Regardless of the reason, oil and gas prices are skyrocketing on tighter global capacity, OPEC’s unwillingness to increase production, and Russia's capacity exiting the market. We expect there to be volatility, but we don’t think we’ve seen the end of higher prices. Even if WTI and gasoline stabilize at the current levels (near $115 per barrel) they are nearly 200% above last year’s level and likely to remain elevated for the foreseeable future. This means an even tighter margin in the Q1 and FY period than previously forecast, weaker than expected earnings, and the possibility of economic stalling. We just paid $4.39 gas, that’s going to cut into the discretionary spending and that’s not good for S&P 500 earnings, not one bit.
The S&P 500 Technical Analysis Today? Bearish With A Chance Of New Lows
The S&P 500 is in a near-term downtrend that is in grave danger of turning into a rout for the bulls. The market has already broken bullish support at the 4,300 level and now the near 4,200 target is under pressure as well. It is possible the market will reestablish a foothold at this level but we think it would be a temporary pause in action until earnings revisions begin coming out. Assuming support holds at this level, and the news begins to get better, the S&P 500 may rebound up to the 4,400 level where we would expect to see stiff resistance.
Longer-term, we are expecting to see price action move below 4,200 and test for support at the lowest low of the current movement at 4101.75. If that level doesn’t hold the next target for strong support is at 4,000 and then 4,800. If the selloff is strong and turns into a pandemic-like run for the exits this action may happen in days and lead the index down to the 3,300 level or lower, down to the trend line at or near the 2,700 level which would be good for a total decline of 44% from 2022 high.
