The state of markets: is it over yet?

26th May, 2022

Markets have declined, almost uninterrupted, since the start of this year. It has been a painful period, but, so far, the S&P 500 is only flirting with bear market territory. How much more pain might be ahead for stock markets? Or are we through the worst?

There are certainly plenty of reasons to remain pessimistic. The inflation tiger shows no sign of being tamed and price rises continue to defy the expectations of central banks and leading economists. Central banks must walk a tightrope between tackling inflation and not crashing the economy. History suggests they are unlikely to engineer a managed slowdown.
 
Equally, the Federal Reserve has made it clear that it is firmly on the side of tackling inflation. BlackRock’s Investment Institute recently revised its outlook for global stock market lower saying: “The Federal Reserve signaled its focus is on taming inflation without flagging the big economic costs this will entail. As long as this is the case and markets believe it, we don’t see the basis for a sustained rebound in risk assets.” 
 
Stock market valuations have soared in the past two years. At 3,900, the S&P 500 is only just back to where it was in March 2021 and remains around 500 points higher than it was prior to the pandemic. While valuations have moved lower and are now slightly below their long-term averages, they are certainly not ‘cheap’ on most measures.
 
Also, the falls to date have happened on relatively normal trading volumes. There has been no sign of the capitulation that often precedes a bottoming-out of stock markets. There may still be residual selling pressure should there be more bad news on the economy, or the corporate earnings picture started to deteriorate. 
 
Earnings have been a sweet spot to date and their relative strength has helped support stock markets. Apart from a few notable weak spots, such as the retail sector, companies have generally been able to pass on higher input costs and profitability has remained robust. However, there could be looming problems should profitability start to decline, but that’s not happening yet. 
 
The prevailing view appears to be that markets falls are unlikely to abate until it appears that inflation has peaked. This could come as soon as next month and might dampen the enthusiasm of central banks for raising rates. However, with the war in Ukraine still raging, inflation still at multi-decade highs and disposable incomes still falling, there is still a wall of bad news for the markets to digest.

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This article was sourced from Adviser-Hub.co.uk.

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