Broker Check

What Makes This Past Weeks Pullback Worse?

April 23, 2024

The S&P 500 dropped below 5,000 for the first time since late February as last week’s economic data and Fed speak confirmed there will be no near-term rate cuts, while geopolitical risks remained elevated. But despite this uptick in volatility, the decline from the recent highs (which has now reached nearly 5%) still needs to be viewed as a pullback from unsustainably positive expectations, not a sudden and more negative fundamental turn.


Put in plain English, stocks aren’t dropping because things are suddenly “bad.” They’re dropping because they aren’t as good as people were hoping they would be (and those hopes were very, very aggressive). Given that, I want to clearly identify the events that would turn this pullback into something more (meaning something that could put much of the Oct.-March rally in jeopardy). Negative Event 1: Growth slows. This likely doesn’t come as a surprise because even since the hot CPI report two weeks ago, I’ve said growth now must hold up to support these markets. The reason is simple: If growth rolls over, we’re looking at stagflation. In stagflation, the market can trade with a 15X or lower multiple. That means a decline in the S&P 500 of over 1,000 points from here (yes, 4,000 would likely be tested). Growth is the single most important influence on the economy and if it shows signs of slowing, look out. Key Indicators to Watch: Unemployment rate, jobless claims.


Negative Event 2: Rate hikes back on the table. Last Thursday stocks dropped when New York Fed President Williams stated that while rate hikes weren’t his “base case” the Fed would hike if the economy warranted it. That’s not a controversial statement in reality, but just the mere mention of rate hikes spooked markets and rightly so, as the lion’s share of the Oct.-March rally has been driven by markets assuming rate hikes were over. If they are not, it’ll create a major valuation reset and a give back of the entire rally is reasonable. Finally, the Fed flip-flopping on cuts vs. hikes isn’t unheard of. For those of us in the business back in the 1990s, it was a relatively routine occurrence. It’s only been since the early 2000s that the Fed has shifted to this longer, drawn out cut/ hike cycle. Point being, it’s not impossible the Fed flip-flops of the data warrants it. Key Indicator to Watch: Fed Watch and rate cut expectations.


Negative Event 3: Oil spikes. The most likely reason for rising oil prices would be if we see the conflicts in Russia/Ukraine and Israel/Hamas spread regionally, but there are other possibilities including disruption of global shipping, OPEC supply cuts and other possibilities. Rising oil would increase headline inflation and while the Fed largely looks past short-term energy price increases, the optics and politics of high oil and higher inflation would likely eliminate the possibility of a rate cut. Meanwhile, higher oil costs would essentially present a “tax” on the economy, increasing slowdown changes. Key Indicator to Watch: WTI crude oil prices, especially if they move towards $100/bbl.


Negative Event 4: AI Enthusiasm Wanes. AI enthusiasm hasn’t been the reason stocks have rallied, but it has contributed to the size of the gains and that’s why AI enthusiasm matters. If investors begin to doubt the transformative power of AI, that will add downward pressure to tech which will not only weigh on the S&P 500 due to tech losses but also create downward valuation pressure as earnings growth prospects will dim. This would increase the intensity of any ongoing decline in stocks. Key Indicator to Watch: NVDA. It’s the darling of AI enthusiasm and earnings on May 22 will be watched closely (they need to continue to beat expectations).


Bottom line, while the pullback in stocks likely isn’t over, it’s important to realize that all the decline has achieved so far is to remove some market excess and put the S&P 500 closer to more fundamentally supported valuations. But the general macroeconomic set up is still positive. However, that can change and these four events are ones we’ll be watching for, because if they start to occur it will require more defensive positioning.

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