What panic? Stock prices are quickly back to record highs

Bloomberg) – Given the rebound in U.S. stocks, this summer’s sell-off looks more like a pause in the bull market than the beginning of its end.

Of course, traders are having a hard time predicting which way the economy will go, and the recession fears that caused the recent decline could resurface as quickly as they faded. Add to that the US election and geopolitical tensions, which pose further uncertainties.

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But there are some reassuring signs beneath the surface. Among them: The sell-off has affected a relatively small portion of the market and was nowhere near as broad as the declines triggered by the Federal Reserve’s rate hikes, the pandemic and other pivotal events. And while valuations are at risk of being recalibrated again if the economy does indeed sputter, the S&P 500 Index remained above a threshold throughout the recent decline that — at least to technical analysts — signals continued investor confidence.

In addition, the benchmark has already fully recovered its August decline and is now only 2.2 percent away from its record high in mid-July.

Curbing the sell-off

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While the decline that began last month was steep and fast, sending the tech-heavy Nasdaq 100 index into a technical correction within three weeks, it was triggered by only a small number of stocks.

During its trough, only about 5% of S&P 500 members fell to one-year lows, according to data compiled by Bloomberg. That means the decline was far smaller in magnitude than previous ones triggered by major macroeconomic changes. After the rise in inflation prompted the Fed to aggressively raise interest rates in 2022, nearly half of the index plunged to 12-month lows. The pandemic sent about two-thirds to that level.

Limited drawdown

Before last month, the S&P 500 had experienced its longest period without a two percent one-day loss since the start of the global financial crisis in 2007. From one perspective, therefore, the restart seems overdue.

Unlike the Nasdaq 100, whose decline reflected long-simmering concerns about high valuations of technology stocks, the S&P 500 never fell into official correction territory but recovered after a decline of 8.5 percent from its peak.

In 2022, the index fell 25% before making a sustained recovery. And during the global financial crisis, it plunged as much as 57% – and then took four years to fully recover.

About key levels

The S&P 500’s 200-week moving average has been a strong indicator of the index’s lower bound since the turn of the century. The index has recently rebounded after falling below this level during the 2016 economic crisis, the 2018 US-China trade war, and again in 2022.

This time, it didn’t even come close to that threshold at its low. While this also shows how far the index could fall in another sell-off, it also shows that investors were confident enough to get in well before a new low was tested.

Japan is recovering

Japan has been at the centre of global turmoil after tight monetary policy pushed the yen to one of its highest levels this year, prompting hedge funds to sell assets to unwind carry trades financed by cheap loans in Japan.

The currency is now weakening again because policymakers there were quick to reassure markets that further interest rate hikes were unlikely. This has also affected stock prices in Japan.

Warning signs

On the other hand, the economic risk that the Fed waited too long to cut rates has not gone away, so the recent recovery means that a rather soft landing is being priced in, leaving the market vulnerable to further decline if that forecast turns out to be wrong.

One indicator of investors’ expectations can be seen in the performance of stocks that are linked to the economic cycle – or the so-called cyclical sectors – compared to less exposed competitors.

In the US, a basket created by Goldman Sachs Group Inc. that measures relative volatility between groups shows that while cyclical stocks have lagged behind defensive stocks recently, they still price in an economic expansion.

On Thursday, an unexpectedly strong rise in retail sales supported that view, but earlier figures also pointed to a slowdown in job growth and slowing manufacturing activity.

“I’m by no means hitting a panic button here, but compared to other asset classes, the S&P 500 appears to have very little uncertainty priced in,” said Matt Stucky, chief equity portfolio manager at Northwestern Mutual Wealth Management.