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The floor of this stock market may still fall

For the time being, 2023 was the most likely outcome for the stock markets in a trading range. Now, even worse scenarios are on the table.

Last week, the Dow Jones Industrial Average rose 376 points, or 1.2%, the S&P 500 rose 1.4%, and the Nasdaq Composite rose 1.7%. All three declined about 1% after the Federal Reserve raised rates by a quarter point on Wednesday.

The market’s go-nowhere action over the past few days — despite some significant events, such as the Fed speech and Credit Suisse Group (ticker: CS) agreeing to be acquired by rival UBS Group (UBS) — is emblematic of recent trading. . The S&P has bounced between 3700 and 4200 over the past few months.

With the economy slowing, interest rates rising, inflation persisting and earnings forecasts expected to slide, investors may not be excited about stocks. A series of rolling crises as well as the popping of the crypto bubble and recent regional bank failures have kept a lid on big gains, says Chris Senyak, chief investment strategist at Wolfe Research.

Even if investors may be inspired by slowing inflation and the potential end of the Fed’s rate hike cycle, more potential looms. On Senyek’s watch list are commercial real estate and private equity, both leveraged bets in a rising rate environment. “Best case, we’re in a trading range; worst case, the floor collapses,” he says.

Nor is the current crisis going away. It won’t reach the levels of 2008 and 2009, when banks blew up because they had too much leverage and owned too many arcane—and toxic—financial products. But the current issues may remain all the same. “The debt and liquidity crisis doesn’t end in two weeks,” says Qu Nguyen, chief investment officer for equities at Research Affiliates. “This is really a crisis of the Fed’s making.”

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how come? Barry Knapp, founder of Ironsides Macroeconomics, points out that short-term interest rates are now above long-term rates, which is a disaster for smaller banks that borrow at short-term rates and earn higher returns on the rate curve. Of course, they could use interest rate swaps and other methods of “maturity conversion”, but that’s a bit too arcane for some US banks. “They’re just small country banks,” says Knapp, who is also concerned that the stock market could collapse. “They won’t have a large interest-rate swap book.”

Brian Rauscher, head of global portfolio strategy at Fundstrat, isn’t worried about the bottoming out, but he also can’t get excited about the stock market. He says of the current problems, “It’s been a bunch of cockroaches.” However, there is no “recession at the end of the world”.

The mood, in other words, is grim, and the four strategists offer similar advice: Be on the defensive. Carry some extra cash. Stick to quality stocks — those that have solid balance sheets and growth that isn’t dependent on the larger economy. Small-cap stocks are cheaper than usual after falling 18% over the past 12 months, but investors should avoid small-cap bank stocks. Above all, don’t get too excited about the next rally on Wall Street.

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Stocks “could go sideways” for a long time, says Raucher. “Go sideways, go down—one thing I didn’t even mention was going up.” Nor should he have.

write to Al Root at [email protected]


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