The weakness we saw in the stock market last week likely means a 10% correction — or more – has just begun.
That doesn’t mean it’s the end of the world for investors … but it does mean it is time to prepare.
You can do that by paring back on momentum stocks that are at the biggest risk of volatility, and keeping some powder dry for purchases at the bottom of this dip. Because while the correction is coming, it will not signal the end of the world.
Here’s why things are looking rocky, and what it means for your portfolio:
Earnings look shaky: It seems like a reduction in earnings forecasts is a staple of each quarter, and it’s happening again. According to FactSet, the estimated earnings growth rate for the S&P 500 in the second quarter was 4.9%, down from a forecast of 6.8% on March 31. Furthermore, of the 111 companies in the S&P that have issued guidance, a whopping 84, or 76%, have been negative. And that comes after weak first-quarter results.
Warmer weather isn’t helping: I know, that whole -2.9% growth rate for the first quarter and poor corporate earnings was written off as a result of bad winter weather. But it’s naïve to think that warmer weather can replace 100 cents on every dollar lost three or four months ago. In fact, in its recent outlook for the U.S. economy, the International Monetary Fund cut its forecast for U.S. growth this year by 0.8 percentage points to 2%. The reason? A harsh winter — and the resulting permanent loss of some growth potential.
Housing trouble: Karl Case, the economist behind the benchmark Case-Shiller survey of home prices, called the U.S. housing market a “crapshoot.” Meanwhile, inventory continues to rise, with housing supplies up almost 14% year-over-year as sellers start to outpace buyers. When you throw in the fact that 30-year mortgage rates have crept up to around 4.15%, adding to the cost of a mortgage, there seems to be a big risk that housing sales will flat-line.
Price inflation, but not wage inflation: A sharp 2.1% increase in consumer prices this May has many inflation hawks sounding the alarm bells. And as I mentioned in a recent column, inflation in some areas — from food to gas to healthcare costs — is actually much higher than the 2.1% CPI rate. Rising prices alone aren’t enough to freak me out, but wages continue to be stubbornly stagnant and that is indeed a big problem.
Global unrest: First, it was Ukraine and Russia that dominated the news. Then it was the rise of the jihadist group Isis in Iraq and Syria. Now, it’s the Israeli-Palestinian conflict that threatens to pitch the Middle East into further disarray. Beyond the humanitarian crisis in these regions — which should never be overlooked — there are serious macroeconomic impacts from these conflicts, not the least of which is the “risk premium” that will be added to energy prices.
European debt woes resurface: At the same time as all this at home, European equities had a bit of a shock last week as the solvency of a major Portuguese bank was called into question. Shades of the 2011 European debt crisis spooked investors, and stocks across Europe slid as a result. Who knows how this will develop in the weeks ahead.
There are other reasons, and surely the weeks again could either bring more troubling signs or change the narrative in a more positive direction.
But investors need to start paying attention, because last week’s declines could only be the beginning.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.