Sometimes the stock market just rises too high too fast—and needs a correction—a 10% drop or greater.
The
S&P 500 index
has surged 20% since near the end of October—barely three months ago—and a correction may already be under way.
For context, average gains for an entire year are typically in the mid-single-digit percentages, so the recent rise is extreme. Driving the rally are two main factors. One is that the generally declining rate of inflation will free up the Federal Reserve to cut interest rates, moves meant to keep the economy in growth mode.
The other factor driving equities upward is the outsize gains from tech stocks, as many are enjoying sustained profit growth as a result of artificial-intelligence product enhancements. Members of the so-called Magnificent Seven,
Nvidia
and
Meta Platforms,
have seen shares rocket 36% and 29% in 2024 alone.
Gains may have peaked, though, and the S&P 500 now sits just below a record intraday high of 4975 set earlier this month. At least one observer thinks a decline has already begun.
“The first dip is upon us,” wrote Seaport Research Partners’ macro and equities strategist Victor Cossel in a report. “We see an increasing risk of a tactical market correction in the near term.”
One indicator is that fewer stocks are rallying. The percentage of S&P 500 stocks that sit above their 200-day moving averages have now slipped to 72% from nearly 80% a few weeks ago. Given the historical correlation between the percent of stocks above that level and movements in the broader index, the S&P 500 should trade at closer to 4600, roughly 7.5% lower than the index’s record high, Seaport’s data show.
In other words, big tech stocks are responsible for a decent portion of recent index gains, and the S&P 500 could easily falter if those names stumble. Consider that many sectors are down for the year while tech sports a 7% gain. Tech stocks account for almost a third of the S&P 500’s market value according to FactSet, and they likely need to take a break from recent gains. There’s precedent for that, as there have been a couple meaningful drawdowns during their larger rallies since around the start of last year. One big pullback could kick out the legs from under the index if non-tech stocks don’t pick up the slack soon.
They may not, since the Fed isn’t likely to cut interest rates as many times as markets had previously thought. That’s why bond yields have crept higher in the past few days. As long as rates remain a bit elevated, the market will assume that economic growth will slow down. That won’t help most non-tech companies.
Economically sensitive companies such as chip maker Texas Instruments and logistics firm FedEx are already issuing disappointing guidance. These stocks are both in the red so far in 2024, but could rebound in time, aided by rate cuts.
The problem is that “recent hawkish Fed speak raises “policy mistake” risks as Fed speaker commentaries suggest hesitancy to cut,” Cossel wrote.
Any way you cut it, the market is at risk of a correction, if one hasn’t already started.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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