The sell-off in April continues for another day, and investors are adjusting their positions. The S&P 500 index has fallen for three consecutive weeks, and the price action isn’t looking promising this week as well. There are several factors that are making investors nervous, such as the Federal Reserve’s hawkish monetary policy stance. However, there are other important fundamentals also leading the current sell-off in markets.
Here are three important factors impacting the U.S. stock market right now.
Stock Market’s Performance
Before we jump in, this is how the stock market is performing today. The S&P 500 index is down 11% year-to-date (YTD) and Dow Jones Industrial Average has declined 7% YTD. The Nasdaq, the tech-heavy index, has fallen 19% YTD.
Factors Affecting the Stock Market Today
1. The Fed’s monetary policy stance is one of the biggest reasons why we are seeing a sell-off in the U.S. equity markets. The Fed did not adopt a hawkish stance overnight; they have been communicating their message for a while. However, since last week, the sell-off has intensified as traders have begun to digest the Fed’s message.
The current monetary policy stance is perhaps the most hawkish stance adopted by the Fed in decades. The central bank is trying to bring inflation down from its highest level in nearly 40 years.
Initially, Fed Chair Jerome Powell began his communication on monetary policy by preparing the markets for 25-basis points. However, more recently, he has mentioned that the Fed could increase the interest rate in their next policy meeting, which is taking place next week, by-50 basis points. In addition to this, the Fed wants to reduce the size of its balance sheet, and they want to do it aggressively. This has made traders enormously nervous since this kind of monetary policy is highly likely to cut deep into U.S. economic growth.
The fact that inflation is already at a multi-decade high, economic data is losing steam, and the Fed wants to increase interest rates aggressively and reduce the size of the balance sheet doesn’t paint an optimistic picture for riskier assets such as stocks.
2. The supply chain issues are still very much anchored, and China is determined to keep its zero-tolerance policy in place. Recently, China has expanded its covid test to 10 districts, and the fear is that this could lead to further lockdowns if the numbers don’t match satisfactory levels.
Basically, higher inflation in the U.S., a hawkish monetary policy by the Fed, and a zero covid tolerance policy are adversely influencing valuations in the U.S. The current earnings season shows that companies that have reported so far are beating expectations on aggregate. However, a lot of hot air has started to come out, and this is influencing mega-cap stocks.
Last week’s intensive sell-off happened because of the disappointing results from the streaming giant Netflix which failed to impress on subscriber numbers. There are a few reasons why Netflix saw a major drawdown in its numbers, but the factors that are mentioned above, such as higher inflation, are certainly making the situation worse.
It is important to emphasize that Netflix is still a growth stock, in my opinion, and the current sell-off or sentiment around its stock price is over cooked. The company is reshaping its strategies, and it is adopting new realities. It will be no surprise to see the stock soaring once again when it begins a new line of revenue, which is advertisements.
Nonetheless, Netflix is a heavy-weight stock for the S&P 500, and the drop in its valuation has dented sentiments, and small caps companies aren’t powerful enough to push the index out of its misery.
3. Mega-cap companies may have the capacity to digest some of the higher costs, and their profit margins will not get that much influenced by the current situation. However, small-cap stocks or mid-cap stocks are finding the current climate challenging for their profit margins since they do not have enough ability to digest the current price shock. This means that the current support we are getting from small to mid-cap stocks could begin to fade as well.
In addition, mega-cap stocks are sitting on large piles of debt. Given that the Fed is immensely hawkish with its monetary policy, we could see the long-term borrowing price curve moving higher, and if that does happen, we may see more pressure on their profit margins. This is further hampering the sentiment in the markets.
To conclude, it is expected that the market will continue its bear trend until inflation peaks out and aggregate demand and supply stabilizes. The Fed will try to cut down aggregate demand to push prices down to reach target inflation levels. The equity market for the time being may move lower as investors fear inflation, slower growth and higher interest rates.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.