No, we don’t think so. Even as broad equity indexes remain close to their all-time highs, the proportion of stocks in their own ‘bear market’^[1]Bear markets are defined as a peak-to-trough change in the S&P 500 Price Index of at least 19% (USD terms). has recently increased, particularly among speculative growth stocks. This has raised fears that, much like during the collapse of the ‘dot-com’ bubble, a domino effect will see the broader market fall. But economic fundamentals look likely to be supportive of corporate earnings in 2022. Taken together with a measured, rather than abrupt, removal of policy accommodation, we doubt a broader bear market is likely in the near term.

The S&P 500 Index stood 5.5% below its all-time high as of the close of Wednesday. While this is not an uncommon position for the index, less typical is the 20% of constituents that are at least 20% off their 52-week high and in their own bear market. With growth underperforming value so far this year, it is no surprise to see the Nasdaq Composite underperforming the S&P. What may surprise, however, is the revelation that 67% of its constituents are at least 20% below their 52-week high, and 40% are at least 50% below that same level. Clearly, away from the limelight of the larger companies, growth stocks have been under pressure. This divergence began some months ago, and indeed the 2021 figures are stark. For the S&P 500, growth stocks outperformed value stocks by 8.8 percentage points (ppts), while for the Russell 2000®, growth lagged value by a considerable 23.8 ppts.

All growth stocks are not created equal, however. In fact, the number of young and unprofitable^[2]’Young companies’ are defined as companies that have been public for less than five years. Unprofitable companies have had negative net income in two of the last three years. Analysis was … Continue reading companies as a percentage of US equities rose from 8% in 2018 to 13% today. It has been those firms, at the most speculative end of the spectrum, that have borne the most pain. Since February 12, 2021,^[3]The date that the ARK Innovation ETF peaked. This fund invests in early-stage, potentially disruptive companies across a number of industries and sectors. the median return for Nasdaq constituents with a negative forward price-earnings ratio has been -54.9%, contrasting with an index median return of -17.6%. Like long-dated bonds, such equities have a high duration, or interest rate sensitivity, because so much of their value is attributable to cash flows that are expected far into the future. With monetary accommodation being removed and interest rates rising, it is perhaps no surprise that this class of equities has underperformed. This development is consistent with the price action witnessed in other frothy corners of the asset markets, including areas with high levels of retail investor involvement—such as cryptocurrencies and the equity niches of ‘meme’ and SPAC stocks. These are the most exposed market segments once financial conditions begin to tighten after a period of abundant liquidity.

The fundamental backdrop is not indicative of any impending collapse in broader equity indexes. US GDP is set to grow well above trend again this year, with consensus forecasts estimating a rate of 3.8%. Similarly, S&P 500 earnings per share are expected to grow by 8.8% for CY 2022. In addition, measures of the equity risk premium, such as Shiller’s real earnings yield spread, are still materially positive at 3%. This denotes a level of relative attractiveness in equities versus bonds, an attractiveness that was absent prior to the ‘dot-com’ crash when this measure was negative. Inflation is also poised to moderate later in the year, and, as a result, the Federal Reserve is taking a measured approach to the removal of monetary stimulus. All these factors lessen the likelihood of a broad market decline.

Thomas O’Mahony, Investment Director, Capital Markets Research