The last three months haven’t been kind to stock market investors overall, as the benchmark S&P 500 is down 4.3% as of Nov. 2, even with the early November rally.
Joining the S&P 500 in negative territory is the Nasdaq composite index, down 4.9% over the same period, as investors have soured on once-prized technology stocks, at least for now.
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Take the so-called Magnificent 7 technology stocks — Apple Inc. (ticker: AAPL), Amazon.com Inc. (AMZN), Microsoft Corp. (MSFT), Meta Platforms Inc. (META), Google parent Alphabet Inc. (GOOG, GOOGL), Tesla Inc. (TSLA) and Nvidia Corp. (NVDA) — which a surprising number of investors are opting to bypass these days.
Exchange-traded funds, or ETFs, such as Invesco QQQ Trust (QQQ), which maintains approximately 44% of its assets in the Magnificent 7, have also suffered lately. The fund was down 3.9% in the last two weeks of October. The same goes for Vanguard Mega Cap Growth ETF (MGK), which holds 57% of its total assets in the same seven stocks. Its performance was down 3.6% over the same period.
Tesla’s stock has dropped 13.2% over the past month as of Nov. 2, despite this week’s rebound, while Alphabet is down 5% over the same period and Nvidia isn’t doing all that much better, down 2.8%.
What drove larger technology stocks and the overall market down this fall? While stubbornly high inflation, high interest rates and balking supply chains haven’t helped, seasonal issues are in play. That includes end-of-year tax-loss selling, where shrewd investors sell some of their stocks at a loss to balance out capital gains taxes they’ll be paying at year-end, and face-saving “loser” stock sales that allow fund managers to avoid having to list anchor-dragging stocks in their year-end portfolio reviews.
Have investors seen the extent of the stock market sell-off? Possibly not, experts say. Here are the most significant risks that loom large over the stock market as November begins:
— Powder keg in the Middle East.
— Negative consumer sentiment.
— Cyclical realities.
— Overpriced stocks, inflated AI shares.
— Weaker investor sentiment.
— High interest rates.
— Unpredictable Fed.
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Powder Keg in the Middle East
It seems foolhardy to question market performance when approximately half of S&P 500 firms have already reported third-quarter earnings with about 77% besting Wall Street analyst estimates, according to J.P. Morgan.
Yet that sentiment takes a darker turn when the geopolitical conflict between Israel and Hamas is factored in. U.S. policymakers are busy with diplomatic efforts to contain the damage and avoid all-out war in the region, but the clock is ticking.
“The war in Israel appears to be spreading and if this holds true, oil markets could be severely disrupted, sending oil prices much higher and taking a bite out of non-energy discretionary spending,” says Clinton McGarvin, senior portfolio manager at Allen Trust Company, a private wealth management firm. “If the war does expand, even neutral outlooks for markets will prove to be overly optimistic, and U.S. and global equity markets will very likely plunge. The war in Ukraine also has the potential to disrupt global energy markets.”
Negative Consumer Sentiment
While U.S. consumers may take a downbeat view of the economy, it’s perhaps more accurate to say the Great American Consumer is simply beaten up after four years of pandemic, wars, inflation and high interest rates, among other financial disruptors.
“The factors contributing to the strong equity market performance, especially in the first half of this year, have largely ended and are reversing,” McGarvin says. “Thus, we believe the record balances on consumer credit cards combined with the higher interest rates on that credit card debt, the fully spent pandemic benefits, and what we believe to be the end-of-recovery splurge on vacations and similar activities will reduce consumer spending growth to levels well below the level of the last three years.”
“This lower growth in consumer spending will flow through to business spending, slowing the economy, perhaps to just above stall speed,” McGarvin adds.
Cyclical Realities
Stocks don’t steadily rise forever, although some investors may believe that to be the case. The fact is, markets fall for a wide array of reasons and then tend to recover again.
For instance, the S&P 500 fell by 6.2% in 2018 but rebounded by 28.9% in 2019, by 16.3% in 2020, and by 26.9% in 2021, before falling back by 19.4% in 2022. In 2023, the S&P is up again by 12.5% as of Nov. 2, picking up three percentage points just since the end of October.
Stocks have a history of performing in upward and downward cycles, and that’s what investors might see toward the end of 2023. “The market produces 10% to 20% declines every two years or so,” says Michael Rosen, chief investment officer with Angeles Investments. “Investors would do well to ignore them.”
Over time, earnings, or profits, drive equities, Rosen says.
“Earnings have surpassed expectations for each of the past three quarters, so this sell-off is likely related to the rise in interest rates,” he says. “Valuations have adjusted, and going forward earnings will dictate the path of equity markets.”
Overpriced Stocks, Inflated AI Shares
Both U.S. stock and bond markets seem reasonably valued entering November.
“Both markets have reacted to the Fed’s inflation battle and the transition to ‘higher for longer’ interest rates,” says Andrew M. Aran, managing partner at Regency Wealth Management. “Stock market results have been skewed by artificial intelligence-related stocks, while bonds have repriced to higher rates.”
McGarvin says U.S. equities are “somewhat overpriced” right now, and therefore have a downward bias in price expectation.
“We believe the increase in earnings and margins, with about 50% of companies reporting thus far in the third quarter, is likely to be a one- or two-quarter phenomenon,” he notes. “We expect a decline in earnings to take place again next year.”
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Weaker Investor Sentiment
When investors see a tsunami of market impactors, they understandably become skittish.
“Corporate earnings have held up pretty well, but (there is) an increasing likelihood that slower demand and higher funding costs are weighing on their outlook,” Aran says.
Geopolitical risks are adding to that fear of further market downside. “Uncertainty always feeds fear, and with money market funds and short-term Treasury bills yielding 5% or more, many investors are choosing these safer alternatives,” Aran says.
High Interest Rates
High interest rates are here for at least a while longer, Fannie Mae stated in a mid-October research note. That scenario should negatively impact the U.S. economy and is likely to do the same with domestic stocks.
“Personal consumption has not only remained resilient, but recent official data revisions indicate that the consumer has been in a better position than previously thought, increasing the likelihood of an economic soft landing,” says Doug Duncan, Fannie Mae senior vice president and chief economist. “Despite consumer resiliency, the recent rise in interest rates has been precipitous, and in past environments — even with less severe interest rate shocks — this has led to economic dislocations.”
Based on that outlook, Fannie Mae expects to see “a mild economic downturn in the first half of 2024,” Duncan adds.
Unpredictable Fed
The ultimate arbiter of where interest rates go from here is the Federal Reserve, which has been on a rate-hiking mission over the past two years. Since March 2022, the Fed has boosted rates from 0.25% to 5.5% in 11 rate-hike intervals. Right now, there’s little consensus on what the Fed will do in late 2023 and in 2024, which contributes significantly to market jitters.
“With a stock market valuation, it is still all about the Fed and interest rates,” says Robert Johnson, professor of finance at the Heider College of Business at Creighton University. “Recent strong economic reports have served to lessen the probability that the Fed will stop rate hikes and begin lowering rates in the near future. Likely Fed rate reductions have been pushed further into the future.”
“Stock market values are contingent upon yields available in the fixed-income markets,” Johnson says. “Interest rates are critical inputs to the valuation process, and influence the value of stocks and bonds.”
As Warren Buffett put it, interest rates are to stock prices what gravity is to an apple.
“When there are low interest rates, there is a very low gravitational pull on asset prices,” Johnson adds. “The effect of rising interest rates has been to deflate the value of stocks because of the increased incentive to hold risk-free government debt.”
Consequently, any moves the Federal Reserve makes should have a huge impact on the stock market. What course the Fed will take is still up for debate: The U.S. job growth numbers reported on Nov. 3 were 30,000 lower than expected, and the unemployment rate ticked up to 3.9%, giving stocks a boost and making an end to rate hikes seem like a possibility.
So What Should Investors Do Right Now?
Conventional wisdom during chaotic market periods is to take a deep breath, focus on the long haul and generally keep your stock positions stable. History shows that markets always rebound after downscale performance periods, and this market should be no different.
“The bottom line about investing is that you simply can’t time market downturns, and you should simply follow your financial plan,” Johnson says.
If you’re still convinced stocks aren’t the place to be, McGarvin advises moving some portfolio cash to longer-dated bonds.
“When the Fed stops raising rates, the yield on the 10-year Treasury declines by an average of 1% within in the first six to nine months of the end of the rate hikes,” he says. “This time, we believe there are more reasons to believe this will take place again.”
Citing the war in Israel and the real possibility of that conflict expanding, McGarvin notes that investors will flock to safe-haven investments, and U.S. Treasurys are still the safest investments in the world.
“Additionally, while our nearer-term outlook for the economy is no recession, we do believe the risks of a recession in the second half of next year are higher than other investors (may think), but we still think a recession can be avoided at this time,” McGarvin adds. “Thus, rates will fall, and bond prices will rise, helping offset any weakness in equities.”
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Update 11/03/23: This story was previously published at an earlier date and has been updated with new information.
