The S&P 500 Decline: What History Tells Us About Future Market Moves

The U.S. stock market has made a notable rebound, but experts believe that further declines in the S&P 500 may still be on the horizon. Despite an impressive reversal witnessed on Tuesday, the underlying conditions suggest that investors need to prepare for more turmoil. Here’s an exploration of why the decline might not yet be over and what stock investors ought to keep in mind.

Indicators of Economic Weakness Ahead

As the markets react to various economic signals, anticipated further signs of weakness in the U.S. economy are expected to intensify fears of a recession. When investors digest the upcoming U.S. employment report scheduled for March 7, further selling pressure may arise. Current investor sentiment is notably dark but remains mixed enough that it has yet to reach a level that might signal a contrarian buy opportunity.

Though it may seem bleak, the good news is that a full-scale recession is not expected. Instead, analysts consider a run-of-the-mill S&P 500 correction (approximately a 10% decline) as a more probable outcome. Investors need to consider three pivotal takeaways:

• If you were contemplating adding to positions, you might find better prices in the near future.
• If you are a long-term buy-and-hold investor, avoid selling to try to dodge any short-term declines; market timing is notoriously difficult.
• Long-term investors might benefit from stepping up their dollar-cost averaging strategy during this market weakness.

Four Key Reasons for Anticipated Market Further Declines

1. Continued Growth Slowdown

Market analyst Jim Paulsen from Paulsen Perspectives highlights that ongoing contractionary forces are contributing to fears surrounding growth slowdown. Elevated Treasury bond yields, a robust U.S. dollar, sluggish money-supply growth, and rising inflation are at play. Paulsen forecasts GDP growth could slow to around or below 2% by 2025, further fueling recession anxieties.

Illustrating this concept, the relationship between the rising 10-year bond rate and the Citibank Economic Surprise Index indicates a concerning trend. As economic surprises dwindle—historically linked to escalating recession fears—stocks could face additional downward pressure. The 10-year bond rate reached a peak of 4.8% in mid-January, suggesting economic momentum may continue to wane until around April.

2. Deteriorating U.S. Financial Conditions

Bloomberg’s Financial Conditions Index reflects the state of the financial sector, revealing a trend of weakening that has persisted throughout the year. This decline prompted a 10% correction in the S&P 500 in 2023 and contributed to a nearly 20% decline in significant tech stocks in the previous summer. Recent sharp downturns indicate that financial conditions are likely still not fully reflected in stock prices.

3. Market Sentiment Signaling Weakness

The stock market often anticipates economic trends. For instance, when consumers are cautious, they tend to spend less on non-essential items, a trend that affects discretionary stocks. Currently, the performance ratio between consumer discretionary stocks and staples is troubling, with this decline marking one of the sharpest in recent history. Past trends suggest that a decline in this ratio typically precedes a larger downturn in the S&P 500.

4. Investor Sentiment Remains Mixed

In terms of contrarian investment strategies, a lack of exceedingly dark sentiment may signal caution. According to the American Association of Individual Investors (AAII) sentiment survey, bearish sentiment has worsened but hasn’t reached a level that traditionally indicates a buy signal. Institutional cash positions are nearing record lows, while many retail strategists remain notably bullish, clouding the outlook for immediate market recovery.

Looking Ahead: Economic Growth and Interest Rates

In a recent interview, Paulsen affirmed his belief that the U.S. economy won’t slip into recession, predicting GDP growth will slow to about 2% while bond yields drop closer to 3%. The relative stability of private sector balance sheets, which remains a strength this economic cycle, will afford some resilience.

Additionally, Paulsen anticipates the Federal Reserve may pivot toward easing later this year due to these economic growth deceleration trends. Such measures would likely reduce inflation to the target rate of 2%, enabling more conducive conditions for the economy and investors alike.

Conclusion

While the recent stock market reversal might bring some temporary relief, significant headwinds suggest that the S&P 500’s decline is far from over. Investor prudence, mixed sentiment, and weakening financial conditions are all indicators that maintaining a long-term perspective and strategic entry points into the market will be crucial as we navigate these uncertain economic waters.