Wall Street’s sell-off has further to go

The current stockmarket sell-off has been led by tech stocks, but the pain is spreading. The bear market has further to go – US stocks are still expensive, and investors must be wary of relief rallies.

“Here we go again,” says Russ Mould of AJ Bell. “The bear market that is threatening to chew up a lot of the past few years’ gains… looks like so many other downturns that have gone before it.” Bull markets usually “crack at the periphery first and trouble then filters through to core assets”. The plunge in cryptocurrencies was “one early sign of trouble”. Enthusiasm for Spacs has also cooled. Now the wider market is feeling the heat.

Last Friday, Wall Street’s S&P 500 share index briefly entered bear-market territory after falling 20% from the record high it hit at the start of 2022. The index has fallen for seven weeks in a row, its worst such streak since the dotcom bubble imploded in 2001. The Dow Jones Industrial Average has fallen for eight straight weeks, its worst showing since 1932. The tech-heavy Nasdaq index has been in a bear market since March.

Trouble spreads

The sell-off has been led by tech stocks. Eight firms collectively account for 46% of the S&P 500’s losses this year, says Karen Langley in The Wall Street Journal – little surprise given how much the tech giants had come to dominate the S&P. On an equal-weighted basis (which strips out the higher weighting given to big firms) the index has fallen by 13% this year, rather than 18%.

Yet the pain is spreading. The latest sell-off was triggered by poor results from US discount chain Target, heightening fears that retail earnings will slide due to supply-chain problems and inflation. “Other than energy and commodities, there have been few haven sectors,” says Ethan Wu in the Financial Times. That has driven cash hoarding among fund managers to a 20-year high, according to the latest Bank of America global fund manager survey.

Some will be tempted to hunt for bargains, but the point of “capitulation” – when investors lose all hope – has not yet arrived. “Margin debt remains above pre-pandemic levels and call option volume is only back to late 2020 levels.” Bank of America’s wealth management unit reports that clients are “cutting equity exposure from very high to merely high”. For now, these “stubborn remnants of optimism” have prevented an even bigger share-price collapse.

Value investing shines

If history is any guide then this sell-off should have further to go, says Evie Liu in Barron’s. “Of the 12 bear markets since World War II, nine lost at least 25%.” So be wary of “relief rallies”, where markets recover for “about two months before things turn ugly again”. Note too that US stocks are still expensive. “Even after the 20% drop, the S&P 500 is still trading around 18 times earnings.” In past bear markets, “the index didn’t hit the bottom until it reached 12 times”, implying another 30% drop from here.

The outlook for cheaper markets beyond the US is more encouraging, says Chris Watling of Longview Economics, who cites “low tech weightings, the ongoing ‘loose’ monetary conditions and continuing economic growth” in places such as Europe. Notably, the FTSE 100 is flat so far this year, a significantly better performance than that seen on Wall Street.

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