- The S&P 500 is down more than 13% so far in 2022.
- Investors are bearish as the Fed hikes rates aggressively and inflation sits at a 41-year high.
- Michael Pento, founder of Pento Portfolio Strategies, believes the market still has a lot to fall.
As far as Michael Pento is concerned, the sale has only just begun.
Even with the S&P 500 already down more than 13% to start the year, the chairman and founder of Pento Portfolio Strategies, who has worked in the markets for more than three decades, has warned in recent weeks that much of the pain is yet to come for stock market investors.
And that will come sooner rather than later, he said.
“I think the
just getting started, and I think it’s getting worse in the second and third quarters of this year,” Pento told Wealthion, a YouTube channel that produces financial content, in an interview posted April 14.” I think this could be the most substantial bear market the US has ever experienced. »
He added: “This is going to end up being one of the worst trading environments anyone has ever seen.”
Pento made those comments more than two weeks ago, and the S&P 500 has fallen another roughly 6% since then.
The reasoning behind Pento’s downtrend is multiple. One factor is that he thinks earnings estimates for this year are too high at this time, given that the strong pandemic-era fiscal stimulus that supported earnings in 2021 has evaporated this year. . He called the stimulus cut the biggest fiscal cliff since World War II.
Even if earnings growth is nominally positive this year, real earnings growth will be less impressive given inflation, he said.
Weaker earnings growth will lead to slow GDP growth, he said. Consumer spending accounts for two-thirds of GDP.
Since the interview, the Bureau of Economic Analysis reported that first-quarter GDP growth was -1.4%.
And then there’s inflation, which has been fueled by the upsurge in demand amid the reopening of the global economy, China’s COVID-19 lockdown measures and the invasion of Ukraine. by Russia. The consumer price index, the main gauge of inflation, hit 8.5% in March, its highest level in 41 years.
As a result, the Fed has become significantly more hawkish in recent months as it attempts to rein in rising prices. The Federal Open Market Committee raised interest rates 50 basis points this week, the highest in about two decades. The central bank also said it would start shrinking its balance sheet, or essentially withdrawing money from the economy.
Pento said the Fed’s aggressive tightening regime will sink the economy this year, as well as stocks. He added that he believed the economy was already weak.
“It only took one 25 basis point rate hike to invert the yield curve,” Pento said, referring to 2-year Treasury yields rising relative to those on treasury bills. 10 years. Reversals of both yields preceded each
since the 1950s.
“It normally takes 300 basis points,” he said.
Pento suggested the S&P 500 could fall 30-50%. From the January 3 highs, a 50% decline would put the index at around 2,400.
The bigger picture
While Pento’s views are a relatively outlier compared to most Wall Street outlooks, some strategists at
count themselves in the same camp.
Morgan Stanley’s chief U.S. equity strategist Mike Wilson also said on Monday that the bear market in equities was “far from over”, citing the impact of inflation on corporate earnings and the slowdown in future growth thanks to the hawkish policy of the Fed.
“We believe the S&P 500 has a minimum downside to 3800 in the near term and possible as low as 3460, the 200 week moving average if forward 12 month EPS starts to decline due to margin issues and/or recession,” Wilson said in a note to clients. Its bear call is up to 17% further downside from when Wilson issued the rating.
Wilson cited the correlation between the inflation-adjusted earnings return for the S&P 500 and the index’s year-over-year performance.
Wilson also pointed to the decline in the amount of money investors are borrowing to invest in stocks as the reason for the pain ahead.
Guggenheim Partners’ global chief investment strategist Scott Minerd also warned on Monday that the Fed would tighten too much and send the economy into recession late next year.
Deutsche Bank economists made a similar call in April.
“We no longer see the Fed achieving a soft landing,” Luzzetti said in an April 5 note to clients.
Binky Chadha and Parag Thatte, equity strategists at the bank, said a 20% bear market would precede the recession.
Jonathan Golub, chief US equity strategist at Credit Suisse, also told Insider in April that the start of 2024 was his best estimate of when a recession would begin.
But with a target of 5,200 for the S&P 500, Golub is still one of Wall Street’s most optimistic strategists for 2022, and there are many alongside him who see even more upside this year despite the acknowledgment growing risks.
Bank of America’s head of US equities and quantitative strategy, Savita Subramanian, sees the index climbing to 4,600 this year, although she said the risk of recession is now around 33%.
BlackRock’s chief global investment strategist, Wei Li, also told Insider that she believes in staying invested for now and the Fed will orchestrate a soft landing, but recession risks have become higher. relevant since the beginning of 2022.
The median target for the S&P 500 in 2022 among top Wall Street strategists is around 4,900.
Can the Fed pull off a soft landing?
A key part of Pento’s argument is that the US economy is “weak”. That’s debatable, with impressive job gains in recent months, continued strong demand, rising wages and an unemployment rate at a historic low of 3.6%.
But no matter how strong the economy is, it’s still unclear how well it can withstand the squeeze before it breaks. Mortgage rates and interest rates on credit cards and bank loans are increasing dramatically in a short time.
Eventually, rates will reach a level that will crush demand and send the economy into a slowdown. The Fed is trying to thread this rate hike needle enough to bring inflation down without crushing economic expansion – a so-called soft landing.
The neutral interest rate for the federal funds rate — the place between dovish and hawkish policy — is around 2.6%, according to BlackRock’s Li. She said that the bank going over that rate would have disastrous consequences for the economy.
Guggenheim’s Minerd said he was “a big skeptic” of the central bank’s ability to find the neutral rate, and said demand destruction was likely already happening in some areas of the market.
This week, Ken Rogoff, a Harvard professor and former chief economist of the International Monetary Fund, told Bloomberg that he believes the Fed will need to raise rates to 5% to slow inflation.
If Li’s neutral rate projection of 2.6% — which is the same level at which Deutsche Bank thinks the Fed will hike rates — is correct, a scenario like Rogoff’s could be disastrous, and that’s exactly what Pento warns.