So far America’s markets have avoided (just) tipping into bear-market territory. But there are signs that they are entering a new, more worrying phase
America’s stockmarket been this year that only a fool would predict mid-week whether prices will end the week up or down. At the market’s close on May 25th, the500 index of leading American shares looked on course to break a seven-week losing streak—or to extend the rout to eight weeks. Thus far, at least, it has avoided the 20% peak-to-trough decline that is the informal definition of a bear market. But there are signs that America’s markets are entering a new, more worrying phase.
From January until early May, falling share prices could be put down to the effect of rising bond yields, as fixed-income markets responded to guidance from the Federal Reserve that interest rates would be going up a lot and fast. Higher interest rates reduce the present value of a stream of future company profits. Shares were marked down accordingly, especially those of technology firms whose profits could be projected furthest into the future.
Slower growth is one element of a textbook profit squeeze. A consequence of the mostly stable cost base of big businesses is that, when sales rise or fall, profits rise and fall by a lot more. This effect boosted profits considerably last year, but asslows it goes into reverse. The other element of a profit squeeze is higher costs. A variety of bottlenecks have pushed up the prices of key inputs, notably energy. Debt-service costs are rising with interest rates. But the main worry is wages.
Is any relief for investors in sight? Some soothsayers feel they are due a bear-market bounce. Their theory is that if a lot of traders have already sold stocks, there will be fewer potential sellers to drive prices down in the future. But a rally based on more balanced position-taking will not do much to change an awkward macroeconomic backdrop for equities.
If consolation can be found in the present conjuncture it lies in the fact that financial markets have done a lot of the Fed’s heavy lifting for it. Since the start of the year, bond yields have risen sharply; mortgage rates have surged; spreads on corporate bonds have widened; the dollar has climbed; and share prices have slumped.
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