Originally posted on April 17, 2024, updated on April 19, 2024.
The last few weeks for stocks have seen a slow decline, culminating in Monday's almost 2% sell-off, leaving us 5.4% below the peak in March. Time will tell where we go from here, but as of Friday's close, the S&P 500 Total Return Index remains up 4.6% year-to-date, still in positive territory. Keep in mind that this kind of price action is pretty normal, especially after the straight-line upward trajectory equities have experienced since Q4 2023 on the narrative of an AI-led productivity miracle. Markets don't go up forever.
Many factors have triggered this sell-off. First, the Fed set expectations high in mid-March when they proclaimed their intent to cut rates three times this year, barring signs that inflation was back. However, since April 1st, there have been several indications that the economy is still running a bit too hot to cut rates anytime soon. Non-farm payrolls came in way above projections, followed by a March CPI print that was 3.5%, with Core at 3.8%, both above consensus. Several pundits, including Larry Summers, noted that the possibility of a rate hike this year is now back on the table. Jerome Powell said Tuesday that the current state of economic policy should stay in place as inflation continues to make its way closer to the ideal rate of 2% annual growth.
Two other factors have contributed to the sell-off. The escalating conflict between Israel and Iran risks throwing the Middle East into a broader war, with oil prices potentially moving much higher. Markets don't like the unpredictability of wars.
Third, the rich valuations attached to the AI giants, or "magnificent seven," have grown stretched, in part because the market has realized that the current poor state of the US electrical grid cannot accommodate huge growth in data centers and will require an enormous amount of capital investment if the AI revolution is to succeed. Put another way, AI isn't free, and it will take time to realize its impact.
Going forward, how these drivers play out will likely decide where stocks go. Watch out for more exuberant employment, growth, or price stats potentially putting the Fed back on guard against inflation: 3.5% is a long way from the 2% Fed target and moving in the wrong direction from January and February prints in the 3.1-2% range. The Middle East remains a powder keg, so a huge rise in the price of oil, since it's inflationary, would also be of concern to the markets. The fate of the large AI stocks will also move broader indexes since they have such a large share of market capitalization. Finally, look farther out on the horizon for a potential decline in the dollar-driven by concerns about the Federal government's increasing interest rate burden, or a further decline in Chinese growth reducing global demand.
Data Source: Bloomberg
Make the most of these insights using Modelist. We create customized investment models for the fiduciary financial advisor. Get in touch with us at hello@modelist.me for a personal consultation.
Modelist Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.