Here are 5 reasons why rising stocks could be about to turn into a bear market

By Joseph Adinolfi

Some market gurus are beginning to worry that the summer rally on Wall Street is starting to run out of steam, after stocks went from oversold to overbought.

Gene Goldman, chief investment officer of Cetera Financial Group, explained that stocks are likely heading for a pullback, even though the economy is in better shape than many Americans might acknowledge.

“There’s been a lot of good news, but the market needs a little break. We’ve been moving a little too fast, too fast, right now,” Goldman said in a phone interview with MarketWatch.

To back up that view, he pointed to a handful of reasons why Friday’s stock slide could continue into next week, and possibly longer – although he remains bullish on stocks longer term.

Defensive sectors back in fashion

Cyclical sectors outperformed, with equities rebounding in July and early August. But that trend seemed to be coming to an end this week as defensive sectors regained the lead.

“A sign that investors are getting nervous is the underperformance of defensive sectors by cyclicals, and we’re starting to see that now,” Goldman said.

Over the past week, consumer staples and utilities stocks have been the two best performers among the 11 sectors of the S&P 500. As a result, Consumer Staples Select Sector SPDR (XLP), an exchange-traded fund which tracks the sector, rose 1.9%, while the Utilities Select Sector fund SPDR (XLU) gained 1.3%.

On the other hand, the two sectors which performed the worst were cyclical sectors. communication materials and services. The Materials Select Sector SPDR (XLB) fund fell 2.4% for the week, while the Communications Services Select Sector SPDR (XLC) fund lost 3.1%.

Bond yields rise

Rising bond yields are another sign that the equity rally may be about to turn, Goldman said.

Higher Treasury yields can pose a problem for stocks because they make bonds a more attractive investment in comparison. Stocks and bonds often moved in unison at the start of the year as expectations of Federal Reserve monetary policy tightening rattled both assets.

But that dynamic seems to have changed in August. Treasury yields rose earlier this month and started to rise before equities hit a rough patch over the weekend.

The yield on the 10-year Treasury note has risen 35 basis points since August 1 and 14 basis points since Monday to 2.897%.

Bond yields rise as prices fall, and Goldman and others on Wall Street are now waiting to see if stocks will follow bond prices lower.

See: Fed’s Bullard says he’s inclined to support a 0.75 percentage point hike in September

So is the dollar

Rising Treasury yields and slowing inflation helped push the US dollar higher, creating another potential headwind for equities. The ICE U.S. dollar index, an indicator of dollar strength against a basket of rivals, rose above 108 on Friday, hitting its highest level in a month.

See: The US Dollar is on fire and slicing through key technical levels “like a hot knife through butter”

A strong dollar is generally associated with weaker stocks, since it erodes the foreign earnings of US multinationals by causing them to lose their value in US dollars.

Cryptocurrencies are falling

Cryptocurrencies like bitcoin and ethereum are also trading lately at nearly the same rate as stocks, especially megacap tech stocks like Meta Platforms Inc. (META) and Netflix Inc. (NFLX). But the crypto sold off sharply on Friday, leading some to wonder if stocks could be next.

“Another sign of a market pause is crypto weakness. This is a clear sign of a downward risk trend in the market,” Goldman said.

See: “There is no reason to treat the crypto market any differently than the rest of the capital markets just because it uses different technology”: SEC Chief Gary Gensler

Bitcoin fell around 9.5% on Friday, while Ethereum, the second most popular cryptocurrency, lost around 10%, according to CoinDesk.

Stock valuations are out of sync with corporate earnings

Another reason to wonder about the rally in equities is that there appears to be a mismatch between equity valuations and corporate earnings expectations.

As Goldman pointed out, the S&P 500 price-to-earnings ratio rebounded to 18.6 times forward earnings from a low of 15.5 in mid-June. At the same time, expectations for corporate earnings for these same companies over the next 12 months have fallen from $238 to $230.

“Stocks rise on falling earnings estimates,” Goldman said.

Goldman isn’t alone in worrying about rising stock valuations. In a recent note to bank clients, Scott Chronert, Citigroup’s U.S. equity strategist, said the risk of lower corporate earnings by 2023 could create a “valuation headwind” for stocks. .

“We would say tactically selling more strength is warranted,” he said.

US stocks fell on Friday, with the S&P 500 SPX losing 55.26 points, or 1.3%, to 4,228.48, while the Nasdaq Composite lost 260.13 points, or 2%, to 12,705.22 . The Dow Jones Industrial Average fell 292.30 points, or 0.9%, to 33,706.74.

Friday’s losses in stocks pushed all three major equity benchmarks into the red for the week, marking the first weekly declines for the S&P 500 and Nasdaq in a month.

Highlights of next week’s economic data calendar are set to arrive on Friday, when Federal Reserve Chairman Jerome Powell is also expected to deliver his annual address at the Kansas City Fed’s annual symposium in Jackson Hole, Wyo. highlight the Fed’s commitment to fighting inflation.

See: Powell to Tell Jackson Hole Recession Won’t Stop Fed’s Fight Against High Inflation

In addition to hearing from Powell, investors will receive an update on the pace of inflation via the Personal Consumption Expenditure Index, the Fed’s preferred gauge of price pressures. The closely watched University of Michigan confidence survey, which includes readings on consumer inflation expectations, is also on Friday’s schedule.

-Joseph Adinolfi


(END) Dow Jones Newswire

08-20-22 1635ET

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