This year is not starting well for the S&P 500 (NYSE:SPY). After a one-day rally for SPY stock, the index cut through the 20-day and 50-day moving average.
Last Friday, the index fell below a key, slow-moving 200-day moving average. Chart readers will interpret this as a breakdown below a support level.
High consumer price index figures for January are worrisome. The red-hot inflation raises consumer costs. Workers will look at their pay raise of 1% to 7.5% as inadequate. Workers who get no wage increase will demand one. They need income growth to keep pace with inflation. Companies on the S&P 500 will absorb the higher costs, hurting profits. This creates serious trouble for the S&P 500 index.
Selling Pressure on SPY Stock Explained
The S&P 500 tracks leading American firms. The companies with the largest weighting are Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Tesla (NASDAQ:TSLA), and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). Those tech firms sell goods that are largely immune to inflation. Wage inflation may add to expenses. This is not a major concern because their business is growing quickly.
Consumer goods firms lower on the list include Home Depot (NYSE:HD) and Proctor & Gamble (NYSE:PG). They both have a strong brand name. Consequently, they may pass inflationary costs to consumers. Still, if costs keep rising, consumers will eventually react by buying less. Even worse are the group theft. Last year, would-be thieves tried to steal from Macy’s (NYSE:M).
Pharmacy chains also reported organized crime risks in their quarterly report. Consumers are at a breaking point. Inflation is taking money away and a possible contributor to higher theft at retail stores.
Rate Hike Schedule
Lower expected demand is not the only pressure that S&P 500 firms face. The Federal Reserve indicated multiple rate hikes this year. In the last week, markets speculated that the Fed would need to accelerate its tightening.
Allianz chief economic advisor Mohamed El-Erian said that the Fed missed a chance to address inflation concerns. It should have removed the “transitory inflation” phase sooner than November 2021. To the Fed’s credit, a supply shortage is creating temporary inflation. Once supply eases, prices will fall.
Persistent supply shortages, especially in the semiconductor market, could last more than a year. This will lead to higher costs for major items like automobiles.
The Fed also missed the chance to raise rates in January before the CPI data read-out.
Higher interest rates increase the cost of servicing debt. Companies with high debt maturing in the next one to three years must renew them at higher rates.
Investors already started dumping shares of highly indebted firms. For example, General Electric (NYSE:GE) and AT&T (NYSE:T) are components of the index. Both stocks faced selling pressure recently. Expect companies not listed on the index and have a high debt to underperform in the coming year.
Opportunity
The SPY ETF is forming an all-time high “top” after it peaked at the start of 2022. The breakdown to the downside below the 200-day moving average could trigger automated selling in the coming weeks. Despite the drop, investors should look beyond the near-term volatility.
The index has a high weighting in growing technology firms. Microsoft and Apple have the pricing power. Neither firm reported a slowdown in demand.
Desperate for holding winning sectors, pundits cited traditional markets like oil and gas or raw materials as buys. They performed well recently but that trend could reverse. Cyclical markets tend to overshoot on the upside and fall quickly on profit-taking. The S&P 500 index does not depend on unpredictable commodity prices. Investors holding the ETF will get a well-diversified investment in sectors including technology, health care, consumer discretionary, and financials. Energy is an approximately 3.5% allocation in the index.
Risks
Market panic may continue throughout this quarter. Investors are unsure how high inflationary pressures will persist. Since interest rates are a secondary concern, markets will look at monthly CPI figures instead. The longer prices keep rising, the more likely people will ask for higher wages.
Once companies raise wages, they cannot reverse that. The higher cost becomes permanent. From there, inflation becomes a permanent long-term trend market must account for.
S&P 500 Outlook
The three- to five-year earnings per share growth rate in SPY stock are around 15%. The price-earnings ratio is around 20. Aggressive growth investors will look at a PEG (P/E to growth) ratio of above 1x as inexpensive. By comparison, Nasdaq has a weighted average P/E ratio of nearly 30.
Diversified investors may hold SPY stock to get a modest exposure to the technology sector instead.
Your Takeaway
The ever-changing inflation and interest rates will force investors to learn basic economics. They will need to forecast an interest rate schedule over the next three years. As inflation accelerates, rate increases will continue. This would pressure the index’s performance.
Investors have hope.
Inflation will moderate. The supply chain disruption will end. When that happens, price hikes will slow. That will support a higher valuation for the S&P 500.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
