Is a Deeper Stock Market Correction Imminent?

With bond yields in focus, should investors be concerned that a long-awaited correction is finally here?

The US stock market has seen record inflows over the past couple months, fueled by a combination of low interest rate environments, explosive returns, and solid earnings.

Having risen already over 6% year-to-date, the S&P 500 has virtually continued rising unabated until last week when concerns began to mount of rising bond yields. Despite touching a one-year high of 1.61%, few expect the market optimism to wane anytime soon.

Digging deeper, there are more factors at play and a potential correction could be triggered by outperforming sectors – or simply signal a continuing bull run.

Stock Valuations a Sign of Concern?

Many investors and analysts look back to past bubbles to look pinpoint future ones. This is hardly a novel concept though the earnings and valuations currently occurring in the market present a mixed bag.

Up until recently, the S&P 500 managed to have a trailing twelve-month price-earnings ratio of over 40.0.

This is significant given that it’s the highest reading since 2009. The index had risen over 76% since its March 2020 lows, not only paring recent losses but striking fresh all-time highs last month.

Given this performance, it is only normal on the back of a decade-long bull run that investors are fearful of a correction. Still, most people are at a disagreement on when or what a potential correction would even entail.

For most, memories still linger of the last correction and ultimately recession during the Great Financial Crisis. However, this scenario was abnormally severe, and long.

Most corrections are far less severe or sweeping, which could shed light on what a correction this time around would look like. One factor going in favor of a milder correction is the high amount of cash on the sidelines.

Investors and individuals thanks to low-interest environments have more cash than ever before, especially on the sidelines. This could mitigate any potential correction as dips would be largely pared by incoming cash into the market from investors previously individuals currently sitting on cash.

In addition, the advent of such low interest rates has largely eliminated the alternatives for investment, relative to the stock market. CDs, and other instruments have faded in popularity amid an outperforming stock market.

This has played out in the form of millions of new brokerage accounts, including an influx of newer retail investors through popular trading apps such as Robinhood and Revolut.

Liquidity Concerns?

Corrections commonly occur during periods of low liquidity, which is hardly the atmosphere that exists currently. With historic levels and access to liquidity, this is one of the strongest arguments against a deep correction at present.

The US Federal Reserve has seen to this, with multiple stimulus packages helping buoy the market as Covid-19 remains a top priority for all monetary policy.

It is worth noting that despite these seemingly strong foundational elements, the recent market run is very fragile. This was on full display at the end of February with rising bond yields, having overtaken the S&P 500’s for the first time in a year.

The market saw a huge dip, led by the technology sector with risk assets, metals, and equities all experiencing notable declines. Any additional rising of such yields could loom as a potential headwind moving forward and is certainly something to be mindful of.

Other Factors on the Horizon

The market up until the end of last week has been a risk-on environment. This was reinforced by the meteoric rise of cryptocurrencies and other risk assets over the past two months.

As we have seen at the end of February, these assets are not immune to pullbacks, and should be treated with caution for such future moves. Investors pointing to the passage of a $1.9 trillion stimulus package in the US as a potential mover may also be disappointed.

This package is largely priced in, having been a foregone conclusion for weeks. In fact, any setback or scaling back of the package would provide the biggest impact, given the market is pricing in a robust package with aforementioned measures.

Moving forward, certain sectors will remain under greater scrutiny as well for a correction. This includes the previously red-hot technology sector with soaring valuations.

The recent panic surrounding bond yields will also continue to loom, which will clearly inform any short-term decision-making by the Fed as well.

This article was submitted by CMS Prime.

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