Stocks may fall by 10 percent from recent highs — a “correction” in Wall Street parlance — as company profits weaken and economic growth stalls, said Joseph Y. Calhoun, chief executive officer of Alhambra Investment Partners.
The equity market hasn’t had a decline of
more than 10 percent since 2011, when the Federal Reserve completed its second round of quantitative easing. That stimulus plan pumped about $600 billion into the economy with bond purchases that pushed down borrowing costs. The Fed’s third stimulus program ended in October, while interest rates have stayed near record lows.
“Historically, on average, we get a 10 percent correction about every 18 months,” Calhoun said in
an April 5 report. “The current market environment is marked by weakening economic growth, weakening earnings growth and momentum that has stalled. That combination has not been seen for a long time.”
A deeper correction, such as a 20 percent decline that marks a bear market, isn’t likely unless the economy slips into recession, he said. U.S. gross domestic product grew 2.2 percent in the fourth quarter, and economists say any slowing in the first quarter may be short-lived as negative effects from cold weather subside.
“I use two main market indicators for recession — the shape of the
yield curve and
credit spreads — and neither is in recession territory right now,” Calhoun said of bond-market benchmarks that reflect investor estimates of inflation and economic growth. “The yield curve has flattened but is still far from flat or inverted.”
If corporate executives grow more concerned about a slowdown, they may cancel or delay plans to buy back stock. That would weaken a key support for equity prices.
“For now though, I’d expect a lot of companies to couple their earnings reports with buyback announcements in the hope that it will be sufficient to keep their stocks from getting hit too hard,” Calhoun said.
The S&P 500 stock index, now trading at 2,076, has price support in the high 1900s, he said.
“If we break that level, the next support level — and a weak one at that — is the October low at 1820,” Calhoun said. “Going back to that October low would qualify as a real correction and I think we are likely to see it.”
Meanwhile with no signs of economic recession in the next two years, stocks will rise this year as price-to-earnings ratios expand, said Barry Bannister, head strategist at Stifel Nicolaus & Co.
That expansion will come as inflation speeds up and investors become more confident about the global economy.
“We have not seen the complacency, euphoria or interest rates we associate with market tops,” Bannister said in
a March 23 report obtained by Newsmax Finance. “We expect a late bull market P/E expansion to lift the index to our 2,350 target price.”