The longest stretch without a 3% pullback in US stocks came to a shuddering halt on Friday, prompted by renewed concern that higher US wage growth may lead to faster interest rate increases.
The S&P 500 Index lost 2.12%, extending its losses from the high seen in late January to 3.85%.
The question everyone is now asking is what will happen next?
Is this the start of a more prolonged and deeper correction in US stocks after years of relentless gains, or is this yet another buying opportunity? Or does the spike in US bond yields mean that economic growth will slow, potentially increasing the risk of a recession in the period ahead?
These are just some of the questions investors are grappling with at present.
While no one can say with any certainty as to what the futures holds, Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, is not overly worried that the recent bout of volatility across markets is a signalling that something more sinister lies ahead, suggesting that unless the US economy enters a recession, this will likely be nothing more than a stock-standard market correction.
“Whether a recession is imminent or not in the US is critically important in terms of whether we will see a major bear market or not,” he says. “Our assessment is that recession is not imminent in the US.”
He provides four reasons why this is unlikely to occur this year.
Along with an unlikely arrival of a recession, Oliver says US earnings growth is also likely to remain strong in the year ahead.
“The December quarter US earnings reporting season is coming in much stronger than expected with profits up around 14.5% year on year and revenue up 8%. And earnings growth expectations for this year have recently pushed up to 16% as tax cuts get factored in,” he says.
So with recession risks muted and the current outlook for US earnings growth strong, albeit that has already largely been factored in by investors, Oliver says while the recent decline in US stocks likely has further to run, it’s unlikely to be the start of a bear market, defined as a drop of 20% or more.
History, presuming that this is not the start of a US recession, is certainly on Oliver’s side based on the evidence in the table below.
It shows every pullback of 10% or more seen in US stocks going back to the 1970s. The decline associated with US recessions are shown in red while those in non-recessionary periods are shown in blue.
In the majority of instances, pullbacks during non-recessionary periods are often smaller, of shorter length and lead to even further market gains over the calendar year in which they occur.
Given history and what he’s seeing in terms of lead indicators on the US economy, Oliver says this points to the likelihood that investors will buy into this latest dip too.
“The pullback is likely to be just an overdue correction with say a 10% or so fall rather than a severe bear market, providing the rise in bond yields is not too abrupt and recession is not imminent in the US with profits continuing to rise,” he says.
“For these reasons the pullback in the direction-setting US share market should be limited in depth and duration to a correction and we remain of the view that returns from shares will be positive this year.”
However, in contrast to recent years, Oliver says that investors will need to be more selective in the stocks and sectors they choose to buy.
“However, it’s increasingly clear that it’s going to be a more volatile year than last year and that share market sectors that are sensitive to rising interest rates and bond yields are likely to remain relative underperformers,” he says.