- If the S&P 500 runs flat for the remainder of the year or begins to stumble, it might be time to reflect on the causes of prior sell-offs.
- Covid knocked down the market in February and March 2020 as the pandemic took hold, but fears surrounding interest rates and China have also contributed to declines.
- Even with a sharp decline, the S&P 500 is still attractive – no matter the headlines.
The market has moved higher for so many years that any deviation from that uptrend has, in hindsight, represented mere annoyance.
However, if the S&P 500, which has been flat for the last quarter, runs sideways through the end of the year, or begins to falter, it might be worth polishing off some analysis on what caused the 5% to 10% sell-offs that have sporadically populated the past decade.
There have been 18 cases since late 2011 when the S&P 500 has declined at least 5% within an eight-week period, using weekly data. A few repeat instigators appear, such as (of course) Covid, which brought down the market by a third last February/March and then hammered away again with two follow-up hits in June and September.
Worries about China, principally trade and domestic slowing, triggered more downturns than any single cause, as the table below illustrates, with the 13 worst sell-offs since 2015. This underscores the looming importance that U.S. investors attach to China. Concerns about rates – rising, falling, and inverting – hold the second spot on the scare-factor list.
The fuel for notable declines between late 2011 and September 2015 was fear about the global economy. Investors sold on rumors of defaults by Greece, Spain, and Italy, as well as the failing recovery of the EU post-financial crisis.
In the final analysis, investors pay more for higher earnings, so what matters most to the market is whether forward earnings will surpass or fall short of expectations. Eye-catching headlines may play a role in the earnings equation, but the professional investor's job is to determine which ones will have a meaningful and sustained impact.
One approach is to consider how the four key elements that weigh on investors' minds today: Covid, inflation, higher interest rates, and China, will play out over the next year, with attention to the effect on corporate earnings.
The delta-variant surge has created havoc with every segment of the supply chain. Despite delays in everything from Amazon Kindle e-readers to truck engines, increased vaccine distribution will inevitably raise the global vaccination rate, mitigating Covid's negative effect on world economies.
Higher inflation has been an unmet goal of central banks for a decade. While we may prefer a range of 2% to 3% over zero, markets gnash their teeth at the notion of runaway prices for everything from vegetables to semiconductors and bicycles. Six months from now, many of the current bottlenecks should resolve in part, if not fully. Higher wages are inevitable, but less stimulus will bring more workers back to jobs and fewer Covid cases should balance out some inflationary pressures.
Interest rate moves are a continuous source of market stress. We know the Federal Reserve is likely to taper, and rates should climb as the recovery continues. However, the Fed may be reluctant to risk the decapitation of growth it helped restore last year, unless there are clear signs of overheating. In addition, the market has advanced through many years of 4%+ inflation and interest rates. You kids just weren't born yet.
China – what do we really know, and what can we say? They need us and we need them. Each China scare migrates from a rapid boil to a low simmer over weeks or months, and while the water stays hot, earnings advance and the market focuses elsewhere.
Where does that leave us? At 4,300, the S&P sells for 19.5 times 2022 earnings, not cheap, but not expensive, even considering upward pressure on inflation and rates.
The average peak-to-trough decline per year, since 1980 is 14.3%, through up and down markets, according to data from JPMorgan. If the market fell 10% from here, the multiple would be 17.5 times, which we would find attractive despite whatever alarmist headlines were running across the bottom of the screen.
Karen Firestone is chairman, CEO, and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.