There’s a whole lot of hope that the stock market can avoid a severe downturn. So far, the S&P 500 has been able to bounce out of bear market territory (-20%).
Going into this year, however, stocks were extremely overvalued. They were pricier at the start of 2022 than they were heading into the Great Depression.
Additionally, on most measures, they were more expensive than they were going into 2000’s tech bubble or 2008’s financial crisis. That’s one heck of a bubble!
Could stocks avoid a genuine reckoning? When borrowing costs are significantly higher? When the Federal Reserve is attempting to reduce its impact on the money supply via quantitative tightening (QT)? When the Fed is focused on inflation rather than engineering a wealth effect?
The only believable scenario that favors a stock surge is one where the Fed blinks. More specifically, a circumstance where committee members at the central bank reverse course, choosing to forgo the battle against inflation in favor of bailing out assets.
Don’t bet on it.
The greater likelihood? Asset pricing will need to take a more substantial beatdown before the Fed could justify low rate stimulus with more money printing.
Here’s how the bearish downtrend may evolve:
The economy will continue to slow and sentiment will continue to sour. As more folks fret the probability of a recession, selling activity will “catch down” to deteriorating sentiment. Stock selling will beget more stock selling. And by the time the Fed comes to the rescue, the S&P 500 will have plummeted 35%-45% from its peak.