A Stock Market Correction Has Started as A Nightmare Scenario Unfolds

My Comments: I wish I had absolute confidence the writer is correct. I know a correction is somewhere in the future, but without a crystal ball, I remain confused. And worried. But the Omicron variant of the Covid dilemma may be the catalyst to trigger a serious market correction.

By Mott Capital Management \ 26 NOV 2021 \ https://tinyurl.com/yc444ans

Now that the stock market correction appears to be well underway, the final piece of my analysis is now falling into place, with the news of the new coronavirus variant aiding.

The market now realizes the big problem that lies before it, something I have been saying would happen for months. The Fed is now tapering its asset purchases and proposing to do it faster into slowing global growth. An absolute nightmare for an equity market trading at 21.5 times its next-twelve-month earnings estimates.

A Disaster Scenario

S&P 500 chart

The equity market in the US is not priced for a Fed tightening financial conditions when global growth is slowing. Global growth was due to get hit hard anyway as the US dollar rocketed higher and rates in the US climbed. But now, factor in a new coronavirus variant, and global growth is likely to take an even bigger pounding.

Remember, the Fed’s mandate is not to support the global economy, and unless there’s a valid reason, the Fed will not back down from a path of reducing its asset purchases quickly. It will have to walk that messaging back very slowly not to cause a complete panic.

The stock market has a funny way of making things happen at times, especially when it’s in disagreement with the Fed about the potential path of monetary policy. It generally works by increasing volatility and sending the value of asset prices lower. With the minutes now behind us and the next FOMC meeting not until December 15, the market has just three weeks to get the Fed to back off any thought of increasing the pace of the taper.

It’s Never Enough

However, reducing the pace of the taper will not be enough. Like a five-year-old child, the market will soon not want the Fed to taper at all. So that by the time the January FOMC meeting comes, the Fed has stopped the process of reducing asset purchase entirely and holding QE at its December rate of $60 billion a month for Treasuries and $5 billion for MBS securities.

The scenario is the same thing that happened in December 2018 when the Fed was on a path to tighten monetary policy and was raising rates. At the December FOMC meeting, the Fed raised rates against the market’s wishes, and the market battered the Fed until the Fed caved in and halted its rate hiking process entirely by the January meeting. The S&P 500 dropped 8% in just four trading sessions following the meeting.

It started with the November Fed minutes released on November 29, 2018, that noted that almost all the participants believed that further gradual increase in the Federal Funds rate was consistent with the Fed’s objective. It’s important to remember that the S&P 500 had already fallen nearly 7% from its October 3 peak. By this point, the market made one last push higher on November 30 and December 3, and then all hell broke loose, with the index dropping nearly 10% into the next Fed meeting on December 19, and almost 17% in total by December 24.

S&P 500 2018

2018 Deja-Vu

This time isn’t much different, except the Fed isn’t tightening rates but reducing the pace of its asset purchases. But this time may be more complex than the 2018 example. In 2018, the S&P 500 was only trading 16.1 times next-twelve-month earnings estimates by December 3. Now, it trades at 21.5. Ultimately, the PE ratio in 2018 bottomed around 13.6, a drop of about 2.5 points. But it’s worth noting that 2018 PE started the year at 18.7, and so by the time the December sell-off came, there had already been a great deal of multiple contraction, with the PE falling 2.6 points into December. In total, the PE ratio fell 5.1 points through the year.

The PE ratio for 2021 started the year at 22.7, a similar 5.1 drop in the PE ratio overall would leave it somewhere around 17.6, and value the S&P 500 at 3,840, a decline of nearly 17%, assuming NTM earnings of $218.08. However, as the S&P 500 drops, it seems highly likely those earnings estimates would begin to decline due to the prospects of slower growth and the nature of how EPS estimates for the index are calculated.

The market has just three weeks to change the Fed’s mind, and one should not doubt the amount of pain the market can inflict during that time.

But remember, with the market, it’s never enough, and after it gets going, maintaining the pace of the taper, it will want more, like any five-year-old child, and demand for the taper to stop altogether.

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One thought on “A Stock Market Correction Has Started as A Nightmare Scenario Unfolds

  1. Tony B

    Dear lord, I hope no retirees actually pay attention to this gent. He, like the rest of us…..has no crystal ball. The economy is booming…….and all this media about Omicron? Omicron IS the vaccine! This is exactly what we were looking for…..everyone needs to catch this version that appears to be much milder…….and we’ll all have natural immunity. Especially if you are vaxxed…your case will be mild.
    Spanish flu of 1918….it went away after a year and a half, and no one knows why!
    So we’ve got a booming economy, record profits, the pandemic ending, and 1-2 billion people worldwide entering the middle class……and I’m here for it!
    Diversify, and turn off the news.


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