Dow, S&P 500 End Week At New Record Highs—But This Potentially ‘Painful’ Risk Could Spark A 15% Crash

Topline

Major stock market indexes posted new record highs Friday, but Bank of America experts warned in a morning note to clients that the slew of recent records has made the market especially vulnerable to rising interest rates, which could usher in a potentially “painful” market correction as soon as this year.

Key Facts

After closing at a record high Thursday, the Dow Jones Industrial Average ticked up 15 points to 35,515 on Friday as top-performer Disney jumped 1%, thanks to a surprise profit from its theme parks last quarter. 

The S&P 500, which also closed at a record Thursday, jumped 0.2% to a high of 4,468 as several stocks climbed following their own blowout earnings, including Tyson Foods, up nearly 2.3%, and eBay, up 7.5%. 

But Bank of America’s Savita Subramanian cautioned that the S&P, after nabbing three closing highs this week alone, has soared to levels “statistically expensive” on almost every measure her team of analysts tracks. 

“Risks loom ahead,” Subramanian’s team wrote Friday, saying inflation and slower earnings growth expected later this year point to a “painful downside” if interest rates move even modestly higher.

They point out Fed officials have started to “urge tapering,” which would involve raising interest rates to help combat rising inflation. 

Bank of America forecasts Fed tapering talks could begin in September and help lift ten-year Treasury yields, which tend to climb with rising rates, to 1.9% by year’s end—a move the analysts estimate would spark a 15% drop in the S&P as investors cash out of stocks to invest in risk-free Treasurys.

Tangent

In a likely sign of market frothiness, several stocks this week have tanked from record highs after warnings of slowed growth, overhyped valuations and looming supply challenges. E-commerce firm Wish plunged 20% Friday after the company cautioned slowed growth would hurt revenue this year, and vaccinemaker Moderna crashed nearly 20% this week after Bank of America analysts called the stock’s recent surge unrealistic based on the firm’s financials. Meanwhile, chipmakers LAM Research and Micron Technology are down between 9% and 15% since last Friday amid concerns computer chip prices will fall later this year due to supply shortages.

Surprising Fact

The S&P crashed 15% in the fourth quarter of 2018 after the Fed started raising interest rates. “If Fed officials move too soon, that will obviously be a problem for markets as history has proven time and time again,” Tom Essaye, editor of the Sevens Report, wrote in a Thursday note.

Key Background

As markets crashed at the height of pandemic uncertainty in March 2020, Fed Chair Jerome Powell pledged to use the Fed’s “full range of tools to support the U.S. economy” until “substantial further progress” is made toward a full economic recovery. Since then, the Fed has kept interest rates at historically low levels while injecting about $120 billion into the economy each month through bond purchases, fueling stocks on a nearly unabated rally. The S&P has skyrocketed nearly 94% from a mid-pandemic low, while the Dow and Nasdaq are up 85% and 115%, respectively. Fears that the government’s heightened spending could spur problematic inflation have triggered bouts of volatility this year and in recent weeks, forced some Fed officials to rethink policy.

What To Watch For

Experts are keenly watching the Fed’s annual Jackson Hole resort trip slated for the weekend of August 28. “We anticipate Fed Chair Jerome Powell will lay the groundwork for tapering at Jackson Hole, with policy specifics arriving [at the Fed’s next meeting] on September 22,” Vital Knowledge Media founder Adam Crisafulli said in a Friday note.

Further Reading

Dow, S&P 500 Climb To New Highs After Inflation Data—But Here’s Why Tech Stocks Are Still Falling (Forbes)

Inflation Keeps Up Summer Surge, Matching Recent Record (Forbes)

Comments are closed.