U.S. stocks are looking increasingly vulnerable to sharp March pullback, according to a series of data points and Wall Street forecasts, as the Federal Reserve steps-up its hawkish rate rhetoric, earnings projections weaken and market volatility gauges creep worryingly higher.
Stocks, in fact, are coming off their worst week of the year following a Friday sell-off that pulled the S&P 500 down 3.2% for the holiday-shortened period, trimming the benchmark's year-to-date gain to around 3.4%. The Dow, which has fallen for four consecutive weeks, is firmly into negative territory for the year while the rate-sensitive Nasdaq has tumbled 6.6% from its early February highs.
A significant portion of the sell-off can be traced to the January jobs report, published on February 3, which showed a bigger-than-expected headline gain of 517,000 -- and five-decade low unemployment rate of 3.4% -- that kicked off a series of growth and inflation readings that snuffed-out bets on a near-term recession and lifted near-term Fed rate forecasts.
The S&P 500 has given back around 5% since the close of trading on February 2, while benchmark 10-year Treasury note yields have surged more than 55 basis points, rising to around 3.97% in late Friday dealing and testing the technically significant level of 4% for the first time since early November.
The 4% level for 10-year Treasury yields, in fact, guided stocks into their late-season rally last year, with the S&P 500 only gaining traction to the upside when the paper trended back towards 4% in late October.
The close connection between stock momentum and Treasury bond yields is likely to define the benchmark's performance over the next few months, as well, as investors price in a higher Fed Funds rate off the back of faster inflation readings.
Futures traders, in fact, are now pricing in a peak Fed Funds rate of around 5.42%, implying at least three more rate hikes from current levels, while the CME Group's FedWatch is indicating at least a 25% chance that the Fed will lift its benchmark rate by 50 basis points next month in Washington.
Stocks are also having to grapple with rising market volatility just as the fourth quarter earnings season draws to a close -- only 26 S&P 500 companies are set to report this week -- and headline momentum dissipates, with the CBOE Group's key VIX volatility gauge pegged at around 21.1 points.
That indicates traders are expecting a daily swing of around 54 points, or 1.32%, for the S&P 500 over the next thirty days.
The Wall Street Journal, meanwhile, noted that CBOE data suggests investors are buying call options on the VIX-- giving them the right, but not the obligation, to purchase contracts at a fixed future price -- as the fastest pace in two years, suggesting near-term volatility if likely to sharply increase.
That's not a view that Chris Larkin, managing director for trading at E*TRADE from Morgan Stanley, finds immediately compelling.
"Investors are coming to grips with rates being higher for longer and Friday’s hotter-than-anticipated inflation data effectively confirmed just that," he said, but noted that "despite the volatility last week, the VIX may have given a potentially short-term bullish signal."
"While the VIX typically moves in the opposite direction of the market, the VIX ended the week lower than it closed on Tuesday, signaling the options market expected less volatility even as the S&P 500 pulled back," he argued. "Similar episodes since 1990 have been followed by larger-than-average short-term gains."
That said, S&P 500 earnings projections have failed to improve alongside stronger-than-expected economic data -- particularly from the consumer sector -- and an Atlanta Fed GDPNow forecast that suggests the economy is growing at a 2.7% clip.
With 465 companies reporting, collective S&P 500 profits are forecast to fall by around 3.2% from last year, according to Refinitiv data, to a share-weighted $441.2 billion. For the current quarter, profits are set to slip 4.3% to around $424.5 billion.
“Given our view that the earnings recession is far from over, we think March is a high risk month for the next leg lower in stocks." star analyst Mike Wilson of Morgan Stanley said in a Monday client note.
That caution could be reflected in recent data from Bank of America's closely-tracked Flow Show report, which indicated big fund managers pulled around $9 billion from U.S. equity portfolios last week, the fourth consecutive weekly outflow, while adding to fixed income investments as the strongest pace since November of 2021.
And who could blame them? The S&P 500's current dividend yield is around 1.59%, whereas a risk-free 6-month Treasury bill pays a yield of 5.11%.
Still, it's worth noting that while higher interest rates contribute to a key market metric -- stock valuations -- earnings growth is more-closely linked to the economy. And it's there where one of the world's most famous investors remains bullish.
Warren Buffett, whose Berkshire Hathaway (BRK.A) investment vehicle is largely concentrated in five stocks -- Apple (AAPL), Bank of America (BACXL) , American Express (AXP), Chevron (CVX) and Coca-Cola (KO) -- said in his annual letter to investors that "I have yet to see a time when it made sense to make a long-term bet against America. And I doubt very much that any reader of this letter will have a different experience in the future."
"We count on the American Tailwind and, though it has been becalmed from time to time, its propelling force has always returned," Buffett said.
One caveat to that assertion, however, is the fact that Buffett chose to buyback around $2.6 billion in Berkshire Hathaway shares -- while dumping another $16.8 billion in high-profile investments such as Taiwan Semiconductor -- rather than put that cash to work in his 'real economy portfolio'.
“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive)," Buffett said in an unusually defensive defense of his uses of cash.
Perhaps he's right. But he's also sitting on a $130 billion of uninvested money -- much of it in high-yielding U.S. Treasury bills.
That says something, too.
