How Bad Will It Get for the Stock Market?




 

(Bloomberg) -- While it feels like it won't stop, someday it will. To get a handle on when equities might bottom out, analysts and investors turn to everything from valuations to technical analysis and history.

Right now, they're struggling to frame a cheerful message.

It's an inexact science, to put it mildly, particularly when as much is swirling around as it is now. Global growth is slowing, Brexit drags on, a trade war rages, stimulus of all types is being yanked and the yield curve is flirting with an inversion. Still, as bad as it feels, at some point things gets priced in.

"The market today is oversold. Does it mean it won't go lower? No," said Joseph Tanious, a senior investment strategist at Bessemer Trust in Los Angeles, which oversees more than $100 billion. "It's hard to say what is exactly the bottom of something that's so technical in nature."

Going strictly by technical analysis of lines on charts, the message is grim. Tuesday's session saw the obliteration of a level that had held for 10 months, the intraday low on the S&P 500. Below that, barriers thin out. The S&P 500 moved quickly from one round-number milestone, 2,500, to another, 2,450, in just a few hours on Thursday.

One model is the S&P 500's 14-day relative strength index, which dropped into oversold territory for the first time since late October after the Fed decision. That could prime the benchmark for a bounce in the near-term, but recent breaches don't inspire confidence.

The indicator has screamed oversold six different times since the market started rolling over months ago, according to Frank Cappelleri, senior equity trader and market technician at Instinet LLC, and the index still slid.

Morgan Stanley's Mike Wilson said earlier this week that after piercing the 2018 low, the gauge could make a "quick move" to 2,450 -- it did. BMO Capital Market's Russ Visch forecasts a slide to 2,445, a level touched at 2:15 p.m. Another model based on what happens when bounces fail to gain momentum puts the floor at 2,450.

Michael Shaoul, chief executive officer at Marketfield Asset Management LLC, is on the lookout for a more dire scenario. With the S&P 500 failing to hold 2,500, the index risks sinking toward 2,400, a level that acted as buffer during the summer swoon in 2017.

"It is true that valuations for U.S. equities now look much more reasonable than they did a few weeks ago, but it's even true for global equity markets where buyers have remained scarce," said Shaoul. "The best that can be said at present is that the current wave of liquidation looks likely to exhaust itself in the near term."

If it doesn't, what looms below is a full-blown bear market, at 2,344.6 on the S&P 500.

At least one version of history paints a slightly rosier picture. At 16 percent, the plunge easily exceeds the average decline of the past 27 corrections since World War II that didn't swell into bear markets.

But that's a big condition to accept as stocks swerve from one awful day to the next. As of now, the S&P 500 is down 16 percent from its September record and only needs to drop 130 more points to meet the 20 percent threshold. This decline has also been faster than usual. It's been 91 days of pain since the top. That's about three quarters of the length of a typical correction, data compiled by Bloomberg show.

"On this move, we will be in a bear market at some point late this year, beginning of next year," said Laurence Benedict, founder of Opportunistic Trader. "I don't think people understand the amount of damage that's been done. All those things said, I don't want you to jump out of your window. But overall, there's more to the downside."

As far as he can make out, stocks appear to be in a "non-recessionary bear market," Ed Clissold, chief U.S. strategist at Ned Davis Research, wrote in a note. On average, those have lasted 213 days, down 25.4 percent.

"Cyclical bear markets that have not overlapped with recessions have been shorter and less severe than bear markets that have," Clissold said. Supporting this view is the absence of economic data pointing to a decline in gross domestic product. Everything from hiring to profits to factories are booming.

As good as the data is, stocks keep falling. With economists projecting GDP growth of 3.1 percent in the fourth quarter, the S&P is down 16 percent since September. That could mark the first time since 2010 that the economy grew by that much but the S&P fell at least 10 percent in the same period, and just the seventh time since 1969.

That's how it goes in downdrafts -- the volatility betrays analysis. Several valuation models are starting to defy history. Stocks are a screaming buy in one. With a price-earnings ratio sitting at 0.9 times forecast growth for the next few years, the S&P 500 looks like a rare bargain using something known as the PEG ratio. It's only the third time since 1995 when the multiple fell below 1.

Should investor sentiment improve and the PEG ratio go back to 1, that alone would lead to an 11 percent rally for the S&P 500. A return to the historic average of 1.3 would mean a 44 percent upside.

On the other hand, the Fed model, which compares the value of stocks and fixed income, suggests there may be plenty of room to fall until equities look more attractive than the less risky alternative. The spread between the S&P 500's earnings yield -- a loose proxy for how much equities "pay" shareholders -- and 10-year Treasury yields now sits at 3.1 percentage points.

Compare that with 2015, when the Fed initiated its hiking cycle and stocks entered a correction. When the market finally bottomed in August, that difference was a wider 3.9 points, meaning equities were cheaper versus bonds. To get to that big a spread, the S&P 500 would have to drop 11.6 percent from current levels, all else equal, data compiled by Bloomberg show.

But despite all the bad news, investors are looking for the next data point, signal, press conference, news release, tweet -- anything -- that can help turn things around. On the list of things that can resuscitate the markets are positive developments in the trade negotiations with China, strong upcoming earnings reports and rising consumer confidence, among other things.

Should the U.S. and China resolve their trade dispute, markets might finally take a breather, Chris Gaffney, president of world markets at TIAA Bank, said in an interview.

"If we can put that big piece of uncertainty away, if we can file it away -- it gives companies confidence that they can start investing more on the capex side," Gaffney said. "Trade is the main trigger that could boost these markets."

That rang true to Tom Plumb, president of Plumb Funds, who expects that China might indicate that there's a positive direction in trade negotiations and that the Trump administration might signal it's comfortable with negotiations.

"People are thinking, at this point it won't take much. People are on the sidelines waiting for an entry point and if they think they're starting to see it, they may rush back in."

--With assistance from Luke Kawa.

To contact the reporters on this story: Vildana Hajric in New York at vhajric1@bloomberg.net;Sarah Ponczek in New York at sponczek2@bloomberg.net;Lu Wang in New York at lwang8@bloomberg.net;Elena Popina in New York at epopina@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

For more articles like this, please visit us at bloomberg.com

©2018 Bloomberg L.P.

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