There is no denying that the stock market has enjoyed a reassuringly strong rally over the past six months. But trader and investor sentiment now seems to have shifted, and indices such as the S&P 500 Index have registered a fall for the third straight week. Furthermore, the tech-heavy NASDAQ was lower for the fourth week in a row. The pullback so far has been around 5.5%, with the NASDAQ down around 7%. These are indeed meaningful figures, but we are not yet in the grips of a crisis. Some other areas of the market that are interest-rate sensitive – such as small-caps and real estate – have admittedly seen larger falls.
This recent correction has seen the VIX Volatility Index – sometimes referred to as the “fear gauge” – climb to its highest this year so far. Since the start of the month, uncertainty regarding the direction of interest rates and increased levels of geopolitical risk have combined to catalyse a shift in investor sentiment. Fed officials have also expressed concern over recent economic data: there has been a spike in inflation, consumers are continuing to shop and the housing market is showing signs of stress. The Federal Reserve Bank is therefore more guarded as far as cutting interest rates is concerned, and its actions will be even more data-dependent.
The markets are now therefore pricing in fewer Fed funds rate cuts – perhaps just one cut this year. And they have adjusted for a higher-for-longer interest rate regime. In the UK, higher oil prices and sticky inflation data mean that any interest rate cuts are now likely to be postponed. However, the European Central Bank has reiterated that June remains the likely target date for lowering borrowing costs – barring any unexpected economic shock.
Escalating geopolitical risks and the Middle East have also been putting upward pressure on crude oil and commodities prices. The likelihood is that spot oil prices will average around US$90 per barrel in the second half of this year. But growing hostilities in either Ukraine or the Middle East could cause that figure to spike up closer to the psychologically important US$100 threshold.
However, given the availability of supplies from OPEC+ and the US, the risk of a demand crisis could be averted – particularly in a US election year: Biden will be keen to maintain a stable energy market and a healthy economy. Washington and London, meanwhile, have prohibited the London Metal Exchange, Chicago Mercantile Exchange and other metal exchanges from accepting new aluminium, copper and nickel from Russia. They have barred imports of these metals into the US and the UK.
The Q1 2024 US corporate earnings season is underway, and while companies are outperforming forecasts, the future guidance statements from some have been less than inspiring, suggesting a softer outlook. It's early days, and only some 15% of S&P 500 companies have reported. But the probability of “higher-for-longer” interest rates is likely to negatively impact company and investor sentiment. This will be a crucial week: many of the mega cap technology stocks are reporting, and any weakness here could have implications for further falls on Wall Street and other global markets. Equally, any strong earnings surprises from the tech sector could reassure investors and create additional buyers to the markets.
In many countries, the International Monetary Fund and World Bank are now forecasting a soft landing following a marked period of monetary tightening designed to control inflation. They now believe that the world’s more developed countries will grow a little faster at a rate of 1.7% compared with 1.6% last year. The emerging economies, meanwhile, will grow a little slower at 4.2% compared with 4.3%. Both organisations are predicting that global inflation will fall from 6.8% in 2023 to 5.9% this year… and then to 4.5% in 2025. They specifically mention India as the fastest-growing of the larger economies, with China registering a modest 4.6% in 2024 (damaged by problems in its property sector). The IMF has also predicted that growth in the US (2.1%) will continue to outperform that of the EU bloc.
Overall, although the mood in equity markets has shifted to the downside in recent weeks (with sovereign bond yields moving higher), the magnitude of the pullback has been controlled. Following the 25% rise in the S&P 500 from October to March, a period of consolidation or some profit-taking is completely understandable. So the key question is: will this recent pullback run the risk of turning into a prolonged bear market environment with a drawdown greater than 20% across multiple sectors? So far, the S&P has fallen some 5.5% since it peaked at the end of March. Under the current circumstances, this is manageable.
It would be somewhat premature to consider this anything other than a healthy correction. A bear market tends to occur when the economy is in a recession, for example. That is not currently the case in the US, the UK or the EU. What's more, bear markets tend to occur when central banks are hiking interest rates and inflation is rising – all evidence would suggest that both are declining in the long term. In the quarters ahead, economic activity in most of the world's regions will be characterised by soft landings. While GDP growth may be below trend, it should be possible to avoid recession.
Consequently, the baseline forecast is for the world economy to continue to grow. Inflation will moderate and there will be cuts in interest rates. Given the level of uncertainty in the Middle East, it is difficult to quantify the magnitude of any correction. We continue to believe that periods of volatility and weakness should be used to rebalance and use book cost averaging to gradually add to quality investments within portfolios. This should be done ahead of a potential recovery that will be driven in part by falling inflation and lower interest rates over the coming months.
