The Nasdaq will go into bear market territory and the S&P 500 will suffer a correction, according to Jeremy Siegel.
So far this year, the Nasdaq is down 14.5% and the S&P 500 is down 8.7%. A bear market is traditionally defined as a 20% decline and a correction as a 10% decline.
Siegel spoke to investors via a conference call hosted by WisdomTree Investments, where he serves as senior investment strategy advisor. He is the Russell E. Palmer Emeritus Professor of Finance at the Wharton School of the University of Pennsylvania.
The market is also experiencing a rotation, he said, which will continue. That will hurt technology and other high-P/E stocks and will favor value stocks.
The double whammy for technology stocks are the higher discount rate and their moats. For example, Siegel said other streaming services could eat into Netflix’s market share. It is not clear whether firms like Netflix have a monopoly over technology, which is necessary to maintain their moats. Strong moats are necessary to maintain their lofty price-earnings multiples, he said.
“Bear markets take good stocks down along with the bad,” he said. “Only the good stocks come back.”
The sorting out is already taking place, Siegel said. The S&P minus the technology sector is down only about 4% since its all-time high.
A week ago, GMO’s Jeremy Grantham published a commentary that predicted a significant drop in U.S. equity prices.
Siegel discounted Grantham’s forecast.
He said that three years ago, in early 2019, Grantham predicted a 50% decline, yet stocks are up 90% since then. In 2010, Grantham again said stocks were overvalued and forecast a real return for equities of 0% for next seven to 10 years. But, Siegel said, the greatest bull market in U.S. history followed. “Grantham has made some really bad calls,” he said. “Eventually he will be right, as he was in 2000. But the media ignores those times when he was wrong. I don’t see anything like a 50% drop.”
Siegel also forecasted persistent inflation and higher interest rates, both of which will depend on Fed policy.
He noted that the 10-year yield is 1.87%, which is approximately nine basis points higher than it was when Fed Chair Jay Powell spoke at a news conference earlier in the day. In that conference, Powell emphasized inflation and the strong labor market. But Powell also said that inflation is higher than the “dot plots” forecast in December. Things have gotten worse since then, Siegel said.
Siegel has predicted higher inflation since late 2020 and said that “it is not over.” There will be two CPI reports before the March 16 FOMC meeting. “I see nothing getting better,” Siegel said, with respect to inflation.
The Fed funds futures market predicts four hikes this year. But since U.S. Treasury bonds are a hedge asset against bad outcomes, that market under-predicts rate hikes, according to Siegel. He said we could get eight hikes because inflation is going to “get a lot worse.”
One cannot underestimate the Fed’s plan for rate hikes, Siegel said. “But all it does is react to the data.” In its September meeting, half the participants did not think there would be any hikes in 2022. The other half expected one or maybe two hikes. Three months later, the markets now predict four hikes.
The CPI and PPI come out in the second week of the month. If each of those reports are in the 0.7% range, with 0.4% expected, we could see a 50 basis point Fed funds rate hike at the next FOMC meeting in March, Siegel said.
“The political pressure will build with the next two reports,” he said.
“Letting inflation ravage the consumer does not sell politically,” he said.
The rate of growth of the money supply is the primary driver of inflation, according to Siegel.
Since June of 2020, the money supply has been increasing at its fastest rate on a percentage basis – approximately 15% – in 150 years, according to Siegel. “We have to slow it down to a 5% to 5.5% increase,” he said, to get inflation to 2%. That was the growth rate during the three decades prior to the pandemic.
He said the cause of inflation is 20% due to supply-chain problems and 80% due to Fed policy.
Interest rates are heading higher, according to Siegel. The Fed will be selling 10-year bonds, and the question is at what price the market will absorb it.
We have $4 trillion more on bank balance sheets than in 2018, he said, when there was a repo crisis due to illiquidity in the Treasury market. Siegel does not expect a repeat of that episode as the Fed tightens. But there is a question about who will emerge to buy federally issued debt.
Expect more frequent inverted yield curves, Siegel said, but those will not foretell recessions as they have in the past.
Powell said that the 2-10-year spread is at its normal range of approximately 70 basis points. But Siegel expects much faster short-term rate increases and the curve to invert. The 10-year could go to 2.5% to 3% in the next year and short-term rates to 3% or 3.5%. But it will not be recessionary, because there is a lot of demand for the 10-year, he said.
“The threat going forward is the Fed going way too fast, way too high,” Siegel said.
He said a 1% Fed funds rate could reduce inflation to 5%, but that still leaves investors with negative real rates. Real rates need to be zero to cool spending, according to Siegel.
Siegel said that the Fed wants to raise long-term rates, which would cool off housing, rather than raising short-term rates. Higher long-term rates could also hurt corporations and the stock market, though.
There is no more Powell put that will keep the market from going down 20%. The Fed will not ease even if the market is down 15% or 20%. “That is not a crisis when you are facing 7% or 8% inflation,” he said.
The Powell put strike price is around 30% or 40% below the market – much lower than most people think, Siegel said.
Robert Huebscher is the CEO and editor of Advisor Perspectives.
Read more articles by Robert Huebscher
The Nasdaq will go into bear market territory and the S&P 500 will suffer a correction, according to Jeremy Siegel.
