The stock market lately is sagging, after a long bull run, in particular springing off the pandemic-induced slide early last year. Numerous worries are to blame, with the new Covid variant high on the list. But there’s a case to be made that the current market distress—stocks fell the first two days this week, part of the ongoing trend—is temporary. Making that case and explaining it are Nicholas Atkeson and Andrew Houghton, the founders of Delta Investment Management in San Francisco:
Larry Light: This too shall pass, eh?
Nicholas Atkeson: The capital markets have never been this hot. The stock market is near all-time highs and interest rates are low. Companies are issuing equity and borrowing money at a record rate this year. Year-to-date, more than $1 trillion worth of equity and nearly $4 trillion of bonds have been sold. When you add loan deals, a total of roughly $8.7 trillion has been raised.
Money raised by corporations generally ends up supporting stock prices. Companies use cash to buy back stock, increase dividends, invest in high return-on-equity businesses, and pay off more expensive debt. Easy and low-cost access to capital is an important component of the foundation of a long-term bull market.
Light: What’s your take on the market’s distress at the moment?
Andrew Houghton: In the short and intermediate term, stock market price weakness over the past five weeks is partly caused by: 1) uncertainty regarding the impact of supply chain constraints, 2) federal government negotiations on managing debt payments and infrastructure spending, 3) higher labor costs, 4) higher inflation, including oil prices, leading to higher interest rates and 5) China’s growth slowdown. These have clouded the outlook. From a technical perspective, our Delta Market Sentiment Indicator turned bearish this week.
Light: None of this sounds too good.
Houghton: Third quarter earnings season begins this week. Analysts have revised down both earnings and GDP estimates for the third quarter with the expectation of a deceleration of growth quarter over quarter. Third quarter GDP growth is expected to be roughly 4%, down from 6.7% in the second quarter.
Light: Demand is a factor here, though.
Atkeson: Much of the longer-term bull case is that demand not satisfied today will be pushed out to the fourth quarter and into 2022. If this assumption is correct, company management teams should offer positive earnings guidance. If supply chain issues are worse than expected, guidance may disappoint and the stock market may pull back further. In the near term, one way to manage this risk is to reduce equity exposure going into the third quarter earnings season.
Light: So the near-term outlook isn’t anything special.
Houghton: September was a negative month for the U.S. stock market. For the third quarter, the S&P 500 traded nearly flat. Since last November, the S&P 500 appreciated on a steady trajectory to a peak closing valuation reached on Sept. 2. With the mild—meaning less than 5%—depreciation in the S&P 500 during September, the positive momentum in the market has dissipated. This can be measured by the current price of the index breaking down through various moving averages.
Technically speaking, the outlook for the U.S. stock market in the intermediate term of one to three months is cautious. If weakness persists, it will become bearish.
Light: Ah, but the longer term?
Atkeson: The longer-term outlook is positive. Technically speaking, the S&P 500 is well above its 200-day moving average, which is a long-cycle technical indicator. Macro-economic data show continued economic growth, despite global supply chain issues, rising labor costs, future Federal Reserve tightening, less government fiscal stimulus, rising inflation and rising interest rates.
Houghton: Based on your investment objectives, risk tolerance and time horizon, and intermediate-term cautious or long-term bullish outlook may stimulate different responses.
For risk-averse investors with a shorter time horizon, the intermediate-term cautious technical signal might drive the investment allocation decision. For investors with more appetite for volatility and a longer investment horizon, you may wish to focus more on the bullish long-term outlook.