We are close to the halfway point of the year and the stock markets seem to be stuck in the red. With the latest 4% drop we saw yesterday, the index S&P 500 is now down 18% below its all-time high and dangerously close to a bear market, defined by a 20% drop from the high.
The S&P 500 has lost 19% from its highs, approaching the 20% “bear market” threshold, as high inflation continues to weigh on equities. In fact, the S&P 500 stock median is already in a bear market (-24% from its highs), as is the Nasdaq Composite (-29% from its highs).
High inflation is still the problemand the ongoing war between Russia and Ukraine, coupled with the Covid lockdowns in China, are the latest bouts of uncertainty affecting the likely timing of inflation improvement.
Investors are increasingly concerned that rising inflation and the Federal Reserve’s plans to address it by sharply increasing interest rates will ultimately trigger a recession.
The inflation issue is complex and the factors have been underestimated. The world energy market faces serious supply problems following insufficient investment in oil and gas since the start of the pandemic and European plans to sharply reduce the region’s dependence on Russian energy imports, with wide ramifications throughout the world economy.
The crisis has led to a redirection of Russian supplies to other importers, an increase in liquefied natural gas (LNG) import/export capacity, and efforts to accelerate the transition to green energy. Nevertheless, in the short and short term, much of the adjustment to limited supply will continue to take place on the demand sidecreating headwinds to global economic growth.
Tech stocks are the main victim
As we can see, the technological values represented by the Nasdaq are the ones who are leading the fall of the market. Let’s think that we started from an area of high overvaluation in the stock markets with technological values leading the increases after the stimuli after the covid crisis and inflation does not sit well with this type of stock.
First, unlike many value stocks, which are valued based on P/E or dividend yield, technology stock valuations often focus on the value of discounted future cash flows at the present time. Consequently, a high dependence on the evolution of interest rates is generated.
The second reason inflation can hurt tech stocks and the market in general is the obvious risk of a recession. When the Federal Reserve raises rates to fight inflation, what it is doing is slowing down economic activity. If it slows down too much, stocks that are highly dependent on economic growth will be comparatively more affected. Hence, the interesting comparison between the valuations of the sector and the evolution of the yield of the US ten-year bond.
Thirdly, if we think about how the assets of these companies are structured, current assets tend to predominate over fixed assets, the latter being the best positioned in inflationary environments due to the level of fixed assets.
Curiously, our Ibex is not doing badly at all. So far this year it barely loses 2.72%. The reasons why it is enduring the hard blow are, firstly, to be characterized by being a wide stock market, dated in the 20th century, with a scarce representation of technological values. Then, within the Russia war conflict, Spain does not have an important commercial relationship with that country, so the issue of dependency on supply will be neutralized.
If we compare ourselves with the German selective that does integrate the variable of the risk of interruption of the supply, today the Dax 30 falls 11.82% in so far this year. The lack of technology companies in the index today is assuming an advantage to quantify the red numbers.