Is a stock market correction on the horizon?
The S&P 500 has taken a dive.
It all started on Sep. 3, when the index closed just 1.5 points below the day prior. Since then, it’s fallen nearly 1.8% since the beginning of the month—only 43 points higher than its lowest day in August—although it had slightly recovered Sep. 15. This has some analysts and asset managers narrowing their predictions for where the U.S. equity market will go over the next calendar year.
“I think we’re in the eighth inning before a correction,” finance professor and author Jeremy Siegel told CNBC earlier this week, noting that he anticipates tech stocks may suffer from the Fed beginning to pull back its pandemic-induced asset purchases, while cyclicals and small-cap stocks may experience a revival.
More than half the stocks in the S&P have already experienced a correction (meaning that they dropped more than 10% in value over some sustained period of time), according to Morgan Stanley research, and small-cap stocks in other indexes are faring worse. Possible culprits abound: There’s the surge of the Delta variant once again putting events on pause. A corporate tax increase on the table. The Fed has slowed its pace of purchasing assets. Inflation figures are higher than expected.
Whatever the cause, a decline in value in the equity markets is disheartening news for investors who have become used to the S&P hitting record after record over the past seven months (equity markets are up nearly 100% since the market crash in March 2020). Is that steady rise over? Here’s what we know.
Doing its own thing
The S&P doesn’t tend to move in tandem with the broader economy. In fact, sometimes it does exactly the opposite. As a refresher: The markets soared to new heights by mid-2020, even as the U.S. economy had effectively shuttered, with businesses shut down and unemployment rates soaring. The markets have also been known to crash on rare occasions during an economic boom.
That disconnect between our lived reality and equity markets is part of a broader shift the S&P 500 has undergone over the past few decades. Ten years ago the U.S. equity markets were more significantly weighted in industrials, energy, and retail. Now, they are “just totally dominated by large-cap tech,” Greg Boutle, head of U.S. equity and derivative strategy at BNP Paribas, said in response to a query from Fortune during an economic outlook press briefing this week.
Here’s a look at the sectors that made up the S&P 500 in 2009, per DataTrek Research:
Now here’s the makeup in 2020:
In a decade, tech has come to dominate nearly a third of the S&P 500’s value, while the energy, retail, and industrial sectors, which are more closely tied to traditional economic indicators, are shrinking in proportion.
What does that mean? First, tech has made the index more defensive to economic instability. Technology companies have experienced a boom during the pandemic-induced surge of online shopping and remote work, which helped hoist up the markets during what otherwise could have been a rough year. Apple, Amazon, and Microsoft made up more than 53% of the S&P 500’s total return in 2020, according to S&P Global Market Intelligence. Remove the S&P’s 30 largest holdings from the mix and the S&P would have actually fallen last year.
Of course, there’s a flip side to that: What happens if tech starts to perform poorly? The Nasdaq-100 Technology Sector Index, which tracks the largest tech companies on the exchange, is up 22.97% this year, but had fallen –0.33% Sep. 14. Of course, that’s a small dip, and the index showed signs of recovery Sep. 15. But given tech’s outsize weighting in the S&P, it’s worth paying attention to.
So is Biden’s corporate tax bill, which is currently on the table. “Our base is that we could easily see corporate tax rates increase by around 5%,” Boutle said. Interest rates are on the rise again as well, which can be a threat to the tech sector’s valuations (here’s a good explainer for why). Economists are predicting the Fed will start raising the federal funds rate in 2022.
It’s not only tech that is down this month, though: Most of the S&P 500’s major component sectors have dipped, including real estate, materials, and health care. The S&P 500 Ex–Information Technology index (which, as you can guess, removes the information tech sector from its holdings), is down 1.04% from the beginning of this month, which is generally in line with the broader index. Energy, on the other hand, is having a great month: That sector is up more than 5% from the beginning of this month.
The outlook for stocks
If investors have longer-term concerns over the continued growth of the S&P 500, it may be worth exploring some other sectors of the equities market. Warning: Some of the alternatives asset managers are looking into aren’t looking too great right now either.
Asset manager BlackRock is neutral overall on U.S. equities, but it’s bullish on U.S. small-cap stocks owing to the rebound of the local economy and the vaccine rollout. The Vanguard Small-Cap ETF (VB), which tracks the investment return of smaller companies, and the iShares Morningstar Small-Cap ETF (ISCB) are two of the more popular funds for this sector. However, they’re experiencing losses this month, too. VB was down 1.59% before market open Sep. 16, and ISCB is down more than 2% from the beginning of this month.
Another place BlackRock is looking? European markets. “Inflows into the region are only just starting to pick up,” the asset manager published in a weekly report. The JPMorgan BetaBuilders Europe ETF (BBEU) is down 1.41%.
BNP Paribas is looking at industrial companies that are cyclical, meaning that they tend to perform better when the economy is. Funds in this arena would include the Industrial Select Sector SPDR Fund (XLI), which is down more than 1.92%.
Some funds that have performed well—though hardly always—during a downturn in the past: the Consumer Staples Select Sector SPDR ETF (XLP)—that fund is down 0.89%—or the Vanguard Dividend Appreciation ETF (VIG), which is down 1.41%.
A reminder: Stock corrections are normal, even if they may be uncomfortable at times. Many analysts are still generally bullish on the markets, particularly after S&P 500 companies posted record year-over-year growth in the second quarter. Buy-and-hold investors shouldn’t be worried: There have been more than 40 corrections in the S&P 500 since 1928, according to Yardeni Research. Should it happen now, and if you’re still bullish on the outlook for the S&P 500, it may simply be a good time to scoop up more exposure at a discount.
This chart from Novel Investor illustrates the influence different sectors have had on the S&P 500 over time, and how they’ve performed during different market cycles. Here is the interactive version.
“Correction”—Corrections are when an asset or indicator (whether that be a stock, bond, or index) drops 10% in value from its latest peak for some duration of time, whether it’s a day or a month. The longest the markets have ever gone without a correction is seven years during the 1990s. On average, it takes the U.S. stock market about four months to recover from a correction, according to a CNBC analysis.
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