Over the weekend, market makers were reading one of the most influential publications in the industry, Barron’s.
One of the article titles had a pretty eye-catching title and was a collection of opinions. The problem is that it had the words “impending doom” in reference to the US stock market.
The reality is that Barron’s is a bit late to the party. There has already been a lot of talk lately that US markets are headed for (if they are not already in) a correction.
This, of course, has important implications across all asset classes. We’ve already mentioned how September is generally the worst-performing month, but now the question is whether that will continue into October.
What’s up with the markets?
The benchmark S&P 500 reached its last high on September 9th and has been generally downhill since then. It’s down a little under 2% for the month so far.
A pullback of a couple of percentage points is normal during a rising market, of course. But those tend to be followed by quick moves higher. Anyone who bought the dip in mid-September might be getting a little impatient.
The more stable DJIA has also been slipping during the same period, but its last high was in mid-August. The thing is, despite companies generally reporting higher sales numbers during the last earning season, since then, companies have started cutting their outlook for the rest of the year.
Most importantly have been the airlines, which have, on some occasions, cut their forecasts twice in a single month.
What’s going on?
There is the usual list of suspects to blame for the situation: the pending Fed taper, the rise in Delta cases, and concern about inflation.
Add to that the expectation that taxes are set to rise, and we get an increased regulatory burden. The problem is that the data now appears to be turning in a negative direction.
Economic growth is slowing, and the expected resolution of the labor shortage problem doesn’t appear to be resolving.
In fact, unless there is a major surprise to the upside in NFP, investors are likely to weigh in one of the primary drivers of stock weakness: margin compression.
Investors have been willing to ignore the issue temporarily given the covid situation. In fact, a short-term period of low profitability in a crisis is expected. But, eventually, the company needs to start making money.
Caught in the crossfire
Businesses are facing margin pressures from both sides.
On the bottom end, there are higher logistics costs plus labor shortages. On the top end, inflation erodes the real value of increased sales.
Rosy projections of increased revenue given in the first half of the year don’t look so good with inflation above 5.0%. Even if companies manage to raise prices, in many cases, it’s just breaking even in inflation-adjusted terms.
If the Fed pulls back its stimulus, it’s going to be harder and harder to justify investing in companies with increasingly higher P/E ratios.
So, it wouldn’t be surprising if talk of a correction keeps increasing for a while.
Eventually, if enough people believe it, it will happen by default. That is, of course, unless we get some unexpected good news over the coming days to contradict the general end-of-the-quarter doldrums.
