2020 and 2021 were both spectacular years for the stock market despite the raging pandemic. 2022 has started off in a much different way as stocks have moved lower despite the world being in a much better place regarding the pandemic due to better treatment options, vaccines, and a significant portion of the population having already been infected.
The two major drivers of stock prices are earnings and interest rates. In 2020 and 2021, both were supportive. Now, we continue to have earnings growth, albeit at a slowing pace, while rates are a headwind. It doesn't' mean that stock prices can't go up, but it does mean that the market will certainly be more sensitive to bad news and likely to endure more volatility.
A recent and pertinent example is the market's rally from Dec. 20 to Jan. 4 which saw the S&P 500 (NYSE: SPY) climb by more than 6% to new, all-time highs. Many believed this was the start of a new leg-up which made sense given that we were entering earnings season, while the omicron variant was proving to be less dangerous and unlikely to have a material impact on economic activity.
However, this breakout turned out to be a "bull trap" as prices quickly reversed, giving up the bulk of its gains in the ensuing sessions. As we look ahead, here are 3 reasons that stocks could encounter more selling pressure in the coming weeks:
Consumer Spending Slowing
One of the engines of the economic recovery has been the resilience of consumer spending. Now, we are seeing real-time economic indicators showing a slowdown. Some are speculating that it's a result of demand for goods dropping, while demand for services is increasing. Others are attributing it to inflationary pressures, finally putting a dent in consumer behavior. Regardless, this is another bullish tailwind that is now neutral at best.
Rates Keep Rising
A contrarian bullish argument could be that the stock market is only off about 7% from it's all-time highs despite the remarkable rise in short-term rates. From mid-August to today, the 2-year yield is up from 0.15% to above 1%.
Rising rates are positive for certain parts of the market like financials and material stocks but it's negative for tech/growth/staples/healthcare. And, there's little reason to believe this trend will abate since inflationary pressures continue to build
Overbought, Overvalued Market
The final reason to be wary in the near and intermediate-term is that the market is overbought and overvalued. Of course, this circumstance doesn't mean that stocks will go down, but it does mean there is more downside in the event of a bearish catalyst.
High inflation and rising rates are certainly such a catalyst. Additionally, the Federal Reserve seems to have no issue with stock prices falling if it means that inflation will go down as well based on their recent statements.