Another week of stock declines but sentiment indicators are getting closer to a contrary “bottom” signal

Ed Mertiri |

TV Interviews with Erin Gibbs

When will the pain end? Bearish sentiment versus fundamentals

 

The market slid another week, setting up January to be one of the worse months for stock market declines since March 2020. But I don’t see a repeat of 2020, nor do I see indications of repeating longer term bear markets like in 2000 or 2008.

Economically and fundamentally, we are in a vastly stronger position. Admittedly, before January we were at valuation extremes. There could be more short-term contraction ahead. However, the forecasts for the economy and corporate profits over the next two years indicate healthy growth. The S&P 500 profit growth is still expected to outpace inflation, growing at 9% this year and over 10% next year. (see chart) Historically, longer term bear markets have come when earnings were contracting, not growing at nearly 10% for two years.

It is feasible the equity markets could drop another 5%, before regaining the losses to a modest gain for the year. There’s still 11 months left for calmer heads to dominate investor sentiment. There are still mixed signals after Friday’s gain, and we may not have hit a bottom just yet. The VIX closed at 32 on Wednesday before dropping just below 30 on Friday. The VIX rarely stays above 30 for any length of time and typically indicates a sharp downturn followed by a sharp upturn. US markets tend towards “V” shaped not “U” shaped recoveries.

Diversification is beneficial during these sharp declines. Emerging and International indices have held up significantly better than the US this month and offer about twice the yield.

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