The S&P 500 has drawn down by more than 7% year-to-date for various reasons. Many analysts cite Russia’s invasion of Ukraine as the catalyst, while others claim that the S&P 500 is suffering from a customary market pullback.
My central claim is that the S&P 500’s recent decline is multifactorial and that we could see a sustained decline in 2022 with a few soft “dip-buying” events along the way.
Most U.S.-based passive portfolio managers use the S&P 500 or the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) as the cornerstone of their portfolios. I’m sure that many will be dumping some weight as inflation’s running hot at 8.5%. Of course, the pull on inflation has been caused by non-core sectors (food & energy), which tend to be highly volatile. However, elasticity to the downside seems unlikely at this stage as an ex-Russia export world will require timely restructuring.
Another concern with the S&P 500 is that it’s top-heavy with many overvalued technology constituents (28.1% of the index). Tech bets generally don’t handle inflation well as they’re bound to a growth sector and lack vertical integration.
To provide an example of the tech sector’s valuation concerns, the Vanguard Information Technology ETF (NYSEARCA:VGT) is trading at 9.92 times its book value and at a price-to-earnings ratio of 29.1x. Call me conservative, but I believe the market has two ends and that investors tend to sell significantly overvalued stocks at some stage, leaving us with a linear growth trajectory instead of a permanent exponential surge.
The final matter I’d like to outline is the S&P 500’s broad-based valuation concerns. According to Yardeni Research, the S&P 500’s trailing price-to-earnings ratio has drawn down to 22.4x, which would be an acceptable valuation if it weren’t for the possibility that we may face stagflation.
As mentioned earlier, the yearly CPI (Consumer Price Index) is currently at a staggering 8.5%, which is roughly four times higher than you’d expect from a healthy economy. The effects of rapid inflation increases could lead to a decline in companies’ earnings and a reduction in stock market liquidity, subsequently causing the S&P 500 to capitulate until the macroeconomic environment retraces to equilibrium growth.
On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) 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.