Weekly Update

Is the Market Selloff Overdone?

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Published May 27, 2022

After seven weeks of declines, the stock market finally found some buyers this week. Still, the trend remains down. The comments below from Delta Research provide a couple of charts to frame the recent declines and what might lie ahead for the stock market in the coming months. Here’s Delta’s analysis:

“In the past week or so, investors have been inundated with plenty of negative news. Walmart, Target and Ross Stores reported declining consumption trends. SNAP reported major advertisers are reigning in spending. The Richmond Fed manufacturing index was -9% for May versus the median forecast of +10 and a prior reading of +14. New home sells were down 16.6% month/month in April. The median forecast was for down 1.8%.

Specific stocks are reacting strongly to specific company news. Walmart, Target, Ross and SNAP all sold off by double digit percentages in the wake of the news releases. But the S&P 500 has held its ground for the past two weeks.

History offers a guide as to why the stock market appears to be absorbing negative news lately without drifting lower. Relative to the 25-year historical average forward P/E ratio for the S&P 500 of 16.85x, the valuation of the market currently has fallen in-line with this historical average.

S&P 500 Index: Forward P/E Ratio

The second reference point is the history of market declines. The average intra-year decline in the S&P 500 since 1980 is 14%. If the S&P 500 were to close at 3900 at the end of 2022, it would be the third worst performance by the index in the past 42 years. This includes the recessions of 1980, 1990, 2001-02, 2008 and 2020 (Covid) shown in red boxes in the chart below.

S&P 500 Annual Returns and Intra-Yr. Declines

If there is no recession in 2022, this would be the first non-recessionary year in the history of the stock market for the past 77 years (since WW2) to close the year with this magnitude of decline.

If you look at the red intra-year declines in the stock market since 1980, you will see several instances when the market was down by about 19% intra-year and closed roughly flat to up on the year. In some cases (1987 and 2020) the S&P 500 was down by more than 30% during the course of the year and ended with a positive return for the calendar year.

Negative sentiment is running high. Institutional investor surveys suggest there is substantial buying interest at the 3500 level of the S&P 500 Index. Markets rarely do what you want them to do.

And, the news is not all bad. Macy’s, Dollar Tree Stores, Dollar General, and Williams-Sonoma all posted better-than-expected results and guidance. The second quarter revision to Q1 included and upward revision to consumer spending to 3.1% from 2.7%. The four-week moving average of jobless claims is at the lowest level since January 17, 1970.”

We know that at a high level, unemployment has a strong correlation to the stock market, with lower levels of unemployment, hence a strong economy, serving as a catalyst for solid stock gains. That has not been the case this year-to-date as investors have been fretful over a number of worries. It’s certainly very possible that those worries dissipate over the summer to set up a market recovery later in the year. It’s also possible that we are only seeing the beginning of a more pronounced retrenchment in the consumer and economy as last week’s earnings reports suggested. We prefer to remain nimble and let our models sort out the prevailing winds, which are changing almost daily of late.

Market Update

After touching bear market territory the previous Friday stocks looked to build on their rebound this week. Monday brought a heavy bout of buying in financial shares as JP Morgan (JPM) updated their outlook to a more positive view. Other cyclical sectors followed financial shares higher to a +1.9% move in the indexes. Tech shares fell -2.3% Tuesday following a warning from social media company SNAP and a weak report on home sales which retriggered recession concerns. Fed meeting minutes released Wednesday combined with better reports from retailers to encourage buyers. Stocks indexes moved higher again with a +0.9% advance. The positive retail news kicked off more buying Thursday to push stocks up another +2%. A strong Friday session built on the rebound momentum with a further +2.5% gain.

A strong relief rally lifted stocks this week as investors received encouraging news from a raft of retailers to counter the prior week’s cautious reports from Walmart (WMT) and Target (TGT). The S&P 500 (SPY) added +6.58% while the Nasdaq 100 (QQQ) rose +7.07%. Smallcap stocks (IWM) gained +6.57%.

Warm regards and until next week.