Big rallies are a thing of the past. The S&P 500 has gone 34 days without rising 1% in any of them, the longest in 20 months. And the pool of companies feeling significant price pressure keeps expanding. More than half the index’s members have suffered peak-to-trough declines of at least 10% since May, data compiled by Morgan Stanley show.
It’s worse in small-caps, where 90% of Russell 2000 stocks have already suffered their own 10% correction.
The listlessness is sowing unease among market pros. While the S&P 500 just managed to fall five straight days without straying more than 2% from its all-time high, some see the stage being set for a more meaningful trip lower. Strategists from Goldman Sachs Group Inc. and Citigroup Inc. have issued fresh warnings on the potential for negative shocks to upend the rally.
“It’s the next six weeks in the market that I have the greatest fear of,” said Phil Blancato, chief executive officer of Ladenburg Thalmann & Co., pointing to a planned reduction in Federal Reserve stimulus and the threat of tax hikes. “The market is at a bit of an ebb tide.”
Stocks fell for the first week in three as mixed economic data kept investors on edge about the timing of stimulus tapering. The S&P 500 declined 1.7% while the Russell 2000 slipped 2.8%. The Nasdaq 100 fared better, thanks to gains in tech megacaps like Facebook Inc.
In fairness, overt expressions of bearishness are few and far between, after sellers were punished amid this year’s 20% runup. Short sellers have been driven almost into extinction while professional forecasters were forced to raise their year-end targets after the S&P 500 surged well past the most optimistic projection made in January.
Hedge funds are cutting their bearish wagers against the broad market. Their short positions against macro products, such as indexes and exchange-traded funds, last week fell to the lowest level since January, according to data compiled by Goldman’s prime broker.
“The fundamentals are still extremely supportive, financial conditions are very easy,” said Seema Shah, chief strategist at Principal Global Investors. “We’re looking at a new phase in the business cycle or at least the next stage of it. We’ve got markets inevitably in transition and this is a time where you have to be really, really careful which companies you’re investing in.”
Shah is right. At the level of individual stocks, corrections are all too tangible. As of Friday’s close, the average stock in the S&P 500 was down 10% from their 52-week highs, according to data compiled by Bloomberg.
Helping keep the market afloat are tech giants like Facebook, Amazon.com Inc. Apple Inc., Microsoft Corp. and Google parent Alphabet Inc., a cohort known as Faang. Without the five, the S&P 500’s 4% advance this quarter would have been halved.
But don’t bet on stocks like the Faangs to continue to prop up the market indefinitely, says Mike Wilson, the chief U.S. equity strategist at Morgan Stanley. Stocks have entered the stage of a market cycle where valuations tend to shrink and even the sturdiest companies can’t escape the drag, he says. Typically, cracks start with the weakest links before the rout goes on to take down the strongest, a process he calls “rolling correction.”
“This rolling correction will end with a consolidation in the higher quality, leadership areas of the market,” Wilson wrote in a client note Thursday. “We think that finishing move will happen in the near term and that it will lead to a benchmark level correction of ~10%.”