Is the Stock Market Crashing?

By Kirsteen Mackay

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With stock market indices plummeting many are asking: is the stock market crashing? Soaring inflation means the Fed must raise rates higher than hoped.

Last week the S&P 500 finished down for the ninth time in the previous ten weeks. It’s now sitting more than 20% below its 3 January closing high. Meanwhile, the NASDAQ Composite Index (INDEXNASDAQ: .IXIC) is down more than 31% year-to-date. And the Dow Jones Industrial Average (INDEXDJX: .DJI) is down 15.9% YTD. This has led many to ask, is the stock market crashing?

The SPDR S&P 500 ETF Trust (NYSEARCA: SPY) is a good gauge of market sentiment. Today it dipped below $380, a key price point thought to trigger algorithmic selling, marking an official entry into bear market territory. 

For technical traders, $380 is the 38.2% Fibonacci retracement of a 2020 low to the January 2021 high. As it bounced from $380 in 2020, there’s hope it can bounce again. But as it’s dipping below $380, the signs are not encouraging. 

Why is the stock market crashing?

Inflation is the headline news destroying the potential for business growth, thus lowering investor sentiment. But bearish market sentiment is accumulating via several sources.

The May US Consumer Price Index (CPI) data showed inflation climbing 8.6%, the highest in 40 years. Food and fuel prices are soaring.

The 2-year to 10-year US Treasury yield curve is a closely watched market indicator. On Friday, it briefly inverted for the first time since April. This is interpreted as a reliable sign of a recession occurring in the next six months to two years. A negative 2-year to 10-year spread has predicted every recession from 1955 to 2018.

A recession will stunt economic growth and make it tough for businesses to thrive.

We can compare this period to previous periods of high inflation, but things are different now. Global debt levels are exponentially higher, and interest rates have been very low for a long time. 

There’s the war in Ukraine, a global energy crisis and a global food crisis unfolding. We’re also facing climate change, among other geopolitical concerns.

Plus, we now have the crypto bubble and insane leverage throughout many parts of the monetary system.

Indeed, short-seller Marc Cohodes recently told portfolio manager George Noble:

No one alive has seen the successive leverage in the market, overlaid with hedge fund leverage, overlaid with ridiculously low rates, and now you have inflation. So no one alive has ever seen this.

Could Hedge Funds Implode?

There are concerns that hedge funds have taken outsized risk over the past year, using the equity in private companies to fund their investments in risky public stocks.

When the private companies were flush with cash, the hedge funds could rest easy.

They were posting massive returns, and confidence soared. They then began to use the equity in their highly valued holdings to borrow more money. 

But inflation is raising the operational costs for these businesses, and private valuations are plummeting.

As the venture capital valuations are down, Tiger Global, D1 Capital, Coatue Management, Lone Pine Capital and Viking Global Investors are all in the firing line.

Taylor Rosanova, head of the fair value group at Marcum, which helps investors mark the value of private investments, told Bloomberg: 

Years of cheap and easy money have driven up valuations. This year company multiples will fall, investor marks will fall, values in totality will fall.

Is this Stock Market Crash as Bad as Previous Crashes?

So far, this stock market crash has been gradual, but there are concerns it could accelerate and plummet in the coming weeks.

The S&P 500 is down 3.8% this morning and the NASDAQ 4.5%.

The most significant and notable stock market crashes in history occurred in 1929, 1987, 1999/2000, 2008 and 2020. 

The 1929 market crash saw the DOW crash 23% in two days and 47.9% in 71 days.

In October 1987, 23 major world markets endured a sharp decline. When measured in USD, eight markets declined by 20% to 29%, three by 30% to 39%, and three by more than 40%.

In March 2020, the S&P 500 entered a brief bear market, dropping around 34%.

Will the Stock Market Continue to Go Down?

The stock market is expected to slide until something happens to appease or reassure investors. For instance, if the war in Ukraine ends, it could bring the oil price down and act as a bullish indicator for stocks. However, any rallies are likely to be short-lived in the current environment.

Legendary investor Stan Druckenmiller recently said he believes that “we're six months into a bear market that has some room to run for those tactically trading.

it's possible the first leg has ended but I think it's highly probable that the bear market has a ways to run. Is it going to be a soft landing? Well, the answer is I don't know, but the probabilities of being a soft landing are pretty remote.

Bear markets are choppy, and there are so many moving parts that affect financial markets and investor sentiment. Therefore, it’s impossible to say for sure when the stock market will crash further or recover.

Is this a Good Time to Invest?

Parts of the stock market will always be investable. Not everything is doomed to head to zero.

Currently, energy, mined metals, agriculture and fertilizer stocks are in favor. Gold is gaining momentum, while uranium and wheat are soldiering on. However, these assets can be volatile, and investors may have missed the boat on some of these trades.

Therefore, this is only a good time to invest if you understand the wider environment and are confident in the stock you are buying shares in. It also depends on your time horizon. If you want to buy shares in Alphabet (NASDAQ: GOOGL) and hold them for ten years, it may not be a terrible idea. But know there’s a high chance Alphabet shares could fall further before they soar. 

And many stocks that have plummeted are still trading on high multiples. For instance, Disney (NYSE: DIS) has fallen 36.5% year-to-date and 44% in a year. Yet it still sports a P/E of 65 and a P/S of 2.3, so it’s not a bargain at today’s price.

Even value investors are wary. A stock considered value with a P/E of 8 could crash further to sport a P/E of 3. That’s why it’s sometimes safer to hold cash until the market plateaus. But if you have a long enough time horizon, bargains can be had while the stock market is crashing.

When Will the Stock Market Recover?

When the stock market begins to recover depends on how far it falls. It also depends on how aggressively the Fed responds to fighting inflation and when inflation peaks.

Currently, the market expects a 75-basis point rate hike from one of the following three Fed meetings. It also predicts the cycle to peak at 3.8% in mid-2023.

The Fed is in a tight spot. To rein in inflation, it must raise rates, which will force a recession and spell bad news for many companies' earnings.

While a stock market recovery is inevitable, it is unlikely to happen this year.

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Market Crash
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Companies:
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Walt Disney

Author: Kirsteen Mackay

This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

Kirsteen Mackay does not hold any position in the stock(s) and/or financial instrument(s) mentioned in the above article.

Kirsteen Mackay has not been paid to produce this piece by the company or companies mentioned above.

Digitonic Ltd, the owner of ValueTheMarkets.com, does not hold a position or positions in the stock(s) and/or financial instrument(s) mentioned in the above article.

Digitonic Ltd, the owner of ValueTheMarkets.com, has not been paid for the production of this piece by the company or companies mentioned above.

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