Breaking News
Get Actionable Insights with InvestingPro+: Start 7 Day FREE Trial Register here
Investing Pro 0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

Selloff In The Stock Market May Be Far From Over

By Michael KramerMarket OverviewMay 06, 2022 06:16
ca.investing.com/analysis/selloff-in-the-stock-market-may-be-far-from-over-200508149
Selloff In The Stock Market May Be Far From Over
By Michael Kramer   |  May 06, 2022 06:16
Saved. See Saved Items.
This article has already been saved in your Saved Items
 

Stocks ripped higher following the Fed meeting on May 4, but that didn't last long. The move higher seems to have been premature, reversing gains on May 5. Investors seemed to have refocused their attention on the critical pieces of the meeting: the Fed would be raising rates and, more importantly, as a result tightening financial conditions.

Financial conditions have already tightened as measured by the Chicago Fed National Financial Condition Index. Since the beginning of this year, those conditions have tightened materially, rising to -27 bps as of Apr. 28, up from roughly -60 bps. Over the same time, the S&P 500 has dropped almost 14%.

Conditions Are Still Easy

However, financial conditions will probably need to tighten even more and head towards neutral for the Fed to succeed. The Chicago Fed notes that when the index is below 0, it is historically associated with looser-than-average financial conditions. In contrast, positive values are traditionally related to tighter-than-average financial conditions.

Despite the current rise in the index, financial conditions are at least historically easy and suggest there will need to be even more tightening to come. We can see the damage that has been caused in the market with the current move higher in financial conditions, which has been around a 32-basis point increase. The pain could be massive, given that we have nearly the same amount of tightening ahead of us.

Financial Conditions Index
Financial Conditions Index

Tighter Conditions Create Pain for Stocks

Historically the data shows that when financial conditions tighten, they tend to be associated with volatility in the S&P 500, which is not different from what we have experienced recently. For example, in 2018, financial conditions tightened dramatically as the Fed raised rates, which sent the S&P 500 plunging by almost 20%.

Similarly, during the rate hiking cycle that started in late 2015, financial conditions increased dramatically in 2014. That period of tightening led to a long period of instability in the S&P 500, and it wasn't until conditions began to ease that stocks finally started to move higher again.

This would indicate that a meaningful equity market rally seems unlikely as long as financial conditions remain tight. Even worse than that, if they tighten further, it will likely lead to more pain for stocks.

How Far Will The Fed Go?

When the Fed talks about tightening financial conditions, it can only mean bad news for stock prices. Given the amount of tightening that is still ahead of us, the problem for stocks can only grow worse. If the Fed intends to tighten conditions beyond the neutral level, making financial conditions restrictive, things could worsen.

This could become particularly painful for stocks with high multiples and little earnings to show for it. The tightening financial conditions will further decline key valuation ratios like the price-to-earnings or price-to-sales. As these valuations compress, their future earnings become worth less, and when a company has no earnings, it makes valuing those stocks even riskier since there may be an uncertain path forward.

Of course, another question is how far will the Fed ultimately go in this process. Still, unless something changes quickly on the inflation front, it seems very hard to imagine financial conditions easing anytime soon.

When these financial conditions peak and begin to turn lower, that will be a clue that perhaps the worst of the equity market selloff is over.

Selloff In The Stock Market May Be Far From Over
 

Related Articles

FactSet Research Systems Inc
Podcast : Financial Market Preview - Friday 5-August By FactSet Research Systems Inc - Aug 05, 2022

US Futures are indicating a higher open. European equity markets have had a mixed start, following broad gains in Asia. Markets are assessing the risk of a policy mistake where...

Selloff In The Stock Market May Be Far From Over

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind: 

  • Enrich the conversation
  • Stay focused and on track. Only post material that’s relevant to the topic being discussed.
  • Be respectful. Even negative opinions can be framed positively and diplomatically.
  •  Use standard writing style. Include punctuation and upper and lower cases.
  • NOTE: Spam and/or promotional messages and links within a comment will be removed
  • Avoid profanity, slander or personal attacks directed at an author or another user.
  • Don’t Monopolize the Conversation. We appreciate passion and conviction, but we also believe strongly in giving everyone a chance to air their thoughts. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (1)
George zarzour
George zarzour May 06, 2022 14:45
Saved. See Saved Items.
This comment has already been saved in your Saved Items
You know, sometimes when i read trash articles like this one it cheers me up for some reason it makes me laugh, its weird !
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email