Stocks: The Worst May Be (Half) Over

S&P: While market worries mount, the S&P 500 index may have already logged most of an expected 20% decline

On Jan. 15, the S&P 500 index set a closing low for this most recent decline at 1380.95, recording an 11.8% sell-off from the Oct. 9, 2007, top of 1565.15. Coincidentally, if the Oct. 9 figure ends up being the high for this most recent bull market, it will have occurred exactly five years to the day after the prior bear market reached its bottom of 776.76 on Oct. 9, 2002. The "500" is not alone in this decline, as the Nasdaq has given up 14% since Oct. 9, and the MSCI EAFE and MSCI Emerging Markets indexes, which track non-U.S. stocks, have fallen 9% and 5%, respectively.

In other words, this has been a global sell-off in response to what we believe is the unwinding of the global growth story (I stole that explanation from Alec Young, S&P's international equity strategist).

Just look at the front page of the Jan. 16 Wall Street Journal to see how widespread the slowdown appears to be. Instead of just a U.S. economic decline, European economic growth is now being called into question. (So much for the "decoupling" of economies and the discounting of the old phrase "if the U.S. sneezes, the rest of the world catches cold.")

Consumer Concerns

Here in the U.S., the concerns are also not confined to the financial sector, as if that weren't reason enough, as banking behemoths play "write-down" leapfrog. Consumer-discretionary outfits have seen their share prices decline for nearly a year, as investors increasingly questioned the ability of American consumers to continue to spend well beyond their means in light of the nationwide decline in housing prices. The recent jump in the unemployment level, however, likely confirmed the scenario that consumers may go from merely complaining about the drop in home prices to fretting about the security of their paychecks.

Add to this mix the consumer-influenced erosion in revenue growth projections from Intel (INTC) and investors have mounting reasons to feel this economic weakness is more widespread and the equity market's price decline has further to go.

It certainly appears to me that prospects for a U.S. recession are on the rise and that investors are increasingly worried that it could become a deep, consumer-influenced recession, as in the mid-1970s or early 1980s, vs. the more shallow recessions of 1970 and 1990, as evidenced by weaker-than-expected retail sales results from Tuesday and the recently negative expenditure comments from higher-end retailers and credit-card issuers.

A Silver Lining, Not a Silver Bullet

If there is a silver lining to this negative news, however, it is that the latest inflation data have offered no additional negative surprises. The year-over-year 2.4% rise in the core consumer price index (which excludes food and energy prices) in December, while still higher than the 2.3% figure we saw last month and increasingly above the so-called Fed comfort zone of 1.5%-2%, at least didn't come in above what the market had been expecting. As a result, we believe the Federal Reserve will likely cut interest rates again when they meet at the end of this month on their way to lowering the Fed funds rate target to at least 3.5% by this summer, from the current 4.25%.

We don't think the upcoming rate cut will be a near-term silver bullet though, as Mark Arbeter, S&P's chief technical strategist, believes this equity market weakness could last until the S&P 500 bottoms out between 1250 and 1275. As a reminder, on Jan. 9 S&P's investment policy committee reduced its year-end 2008 target for the benchmark to 1560 from 1650, and embraced a more cautious investment stance by upgrading the consumer staples, energy, health-care, and utilities sectors to overweight, while downgrading industrials and technology to underweight (the consumer-discretionary and financial groups are the other sectors with underweight ratings).

But with the S&P off about 12% already from its October high, on its way to what we believe will be as much as a 20% decline, it may be comforting to know we may be more than halfway there.