Stock Selloff May Be Entering a New Phase

My Comments: Mohamed A. El-Erian is a globally respected economic advisor and writer. I typically pay attention to what he says. The seven paragraphs here are a powerful insight into what you can expect in the next several months.

If you have significant funds exposed to the markets today, be very careful.

By Mohamed A. El-Erian \ 19 MAY 22 \

This (last) week’s move lower in stocks may not just be a simple continuation of what has already been a painful 2022 selloff for investors. Instead, there are signs that the selloff may have entered a new phase. In addition to deepening the year-to-date losses, this increases the possibility, though still not high probability, of a disruption in market functioning, which would have material spillbacks for the real economy.

The sharp selloff on Wednesday took the year-to-date losses of the S&P 500 Index to 17.7%, and those of the Dow Jones Industrial Average and the Nasdaq Composite Index to 13.3% and 27%, respectively. The initial drivers for these losses came from the financial side of the economy—that is, concerns about higher interest rates and more generally tightening financial conditions. Now there is growing evidence that, while these two influences have mostly played out, a new one is in the driver seat.

Wednesday’s selloff had two particular characteristics that distinguished it from the recent market moves. First, consumer-related stocks led by Walmart Inc. and Target Corp. notably underperformed, losing even more value; and bond prices rose rather than fell as they had for the early phases of the selloff.

Both of these are consistent with worries about growth and earnings becoming a bigger driver of market reaction. They come on the heels of another more-hawkish tilt this week by Federal Reserve Chair Jerome Powell and, as important, remarks from Target suggesting that persistent cost pressures are now being accompanied by concerns about the revenue side and, more generally, the ability of consumers to navigate such high inflation.

Should these worries prove valid—and I suspect they will, given my expectations of a stagflationary baseline—stock prices remain vulnerable notwithstanding the more attractive buying opportunities resulting from this year’s sharp declines. Also, there is a growing possibility for the one risk factor that has yet to play out—disruptions in market functioning, in which pockets of illiquidity frustrate investors’ ability to reposition.

Market-functioning stress does more than erode investor confidence. It also fuels two sources of contagion: generalized spillovers—be it in the form of investors being forced to sell less threatened assets simply to obtain liquidity or by undermining the economy through more cautious corporate behavior—and consumer sentiment.

While the hope is that this week’s market action is a continuation of a selloff that is coming to its end, there is a real risk that it may be more than that—a new phase that threatens both more price losses and a higher possibility of market-functioning stress.