The worst stock selloff in half a century might not be done yet

LONDON (BLOOMBERG) – It has been a chaotic, and costly, time for many investors. But 2022 is only half over and the stocks tale will probably have more twists and turns before the year is up.

Coming off the worst first-half since 1970, United States equities now face a triple whammy of sticky inflation, recession risks and the threat to corporate profits from sinking consumer confidence. After just about everyone on Wall Street got his 2022 predictions wrong. Investors are now focused on a toxic mix that spells stagflation, as well as more damage to valuations.

“The next 10 per cent will probably be down from here, not up,” said Mr Scott Ladner, chief investment officer at Horizon Investments. “A quick market bottom will need a turn in central bank policy, and we don’t think that is a possibility in the next few months.”

Indeed, the Federal Reserve is expected to go on hiking rates as it tries to tame inflation, rather than flush the market with cash like it did in 2008 and 2020 – pretty much the rocket fuel for the powerful bull market that has now come to a halt.

This year is already one of the worst in terms of big daily declines, with the S&P 500 Index falling 2 per cent or more on 14 occasions, putting 2022 in the top 10 list, according to data compiled by Bloomberg going back two decades.

Despite that, the CBOE Volatility Index, the so-called fear gauge, is below levels seen in past bear markets, suggesting that the market has not yet seen the washout needed to spark a sustainable rally.

Based on the history of past bear markets, the S&P 500 should see some rebound by the end of 2022. In recession years, it is a different story, with fresh lows to come first.

Mr Michael Wilson at Morgan Stanley, one of Wall Street’s most vocal bears, says the S&P 500 needs to drop another 15 per cent to 20 per cent to about 3,000 points for the market to fully reflect the scale of economic contraction.

For Mr Peter Garnry, head of equity strategy at Saxo Bank, the bottom is about 35 per cent below January’s record high, implying further declines of about 17 per cent.

“Companies such as Tesla and Nvidia, and cryptocurrencies, must capitulate before the speculative excesses have been eliminated and a bottom has been reached,” Mr Garnry said. Wall Street bulls see a better second half, though it will not be enough to recoup all of the decline so far.

In Europe, strategists in a survey expect the Stoxx 600 to post declines of 4 per cent on the year. It is currently down about 17 per cent.

Amid all the gloom, earnings estimates have remained relatively upbeat. That is going to be tested when US and European companies start reporting second-quarter earnings in two weeks. Demand has so far held up even as consumer mood soured, but there have been signs recently that US spending is softening.

“Spending has been holding up because the gap has been bridged by savings built up during the pandemic,” said Ms Anneka Treon, managing director at Van Lanschot Kempen. “And that is obviously unsustainable.”

There is plenty of scope for downgrades, with global profit margin estimates seen as too optimistic. For Goldman Sachs strategists, margins for US companies will likely decline next year, whether or not the economy falls into recession.