Why Monday’s stock market slide is different – and where we go from here

Stock market dips are like your kids: Each one is different in its own wonderful (and, yes, sometimes infuriating) way.

Monday’s short-lived market slide was a case in point. It was different than other market falls of the past quarter-century, mostly because it came as absolutely no surprise.

Many sage observers had been warning for a while that valuations are stretched. In a compilation of forecasts from 16 top investing teams conducted in early December, half of the big brains had year-end 2022 targets for the benchmark S&P 500 that were either below where the index then sat or just a hair higher.

So don’t see the dip, which was erased by market close, as a big shock. And please, please, don’t drag out comparisons to other stock market debacles of the past 25 years. As volatile and frenzied as recent market activity has been, the current situation isn’t comparable to the truly nasty episodes of recent decades.

It’s not like early 2020, when the world and the stock market suddenly woke up to the dangers of the novel coronavirus. If anything, the situation Monday was the opposite: We have come to grips with the virus and are seeing promising signs we are over the worst of the pandemic.

Neither is Monday’s volatility like the financial crisis of 2008. Back then, the financial sector melted down for reasons that were only dimly apparent at the time.

In stark contrast, the threat Monday is lurking in plain sight. It’s the near certainty that central banks and governments will start withdrawing all the easy money they have pumped into the economy (with jitters over the U.S. vs. Russia showdown in Ukraine added in).

Comparisons to the dotcom crash of 2000 seem even more forced. Yes, technology stocks have roared in recent years, but unlike their dotcom predecessors, most are actually generating healthy profits.

In contrast to the dotcom era, when one sector was driving most of the market gains, this has been an everything boom – all sectors have gained. Proof of that: An equal-weighted index of the S&P 500, in which every company counts for the same amount, has performed nearly identically over the past three years to the traditional S&P 500, in which the biggest and most successful companies dominate the results.

So where do we go from here? The bond market offers some clues.

It doesn’t seem too fussed by the current perturbations. Consider, for instance, the spread between yields on low-quality, high-yield bonds and their more conservative investment-grade counterparts. This spread usually widens dramatically during times of economic crisis because investors in junkier offerings start demanding a higher yield to offset the increased risks of default.

There is little sign that this is happening now. The bond market seems to think the real economy is on solid footing.

The bond market doesn’t seem to be losing much sleep over inflation, either. Its estimate of where inflation expectations for the next five years will sit five years from now – the five-year, five-year forward inflation expectation rate, in the jargon – is practically smack dab on the 2-per-cent target rate for inflation central banks have had for years.

To put that more plainly, the bond market is saying that five years from now – in January, 2027 – inflation for the foreseeable future will be running right in line with what we have all come to see as normal.

All of this should be balm for frazzled nerves. At least according to the bond market, we are not facing an inflationary tsunami that will endure for years. Neither is the economy quaking.

To be sure, this doesn’t mean that stocks are going to go up from here. What seems to be happening now is that central banks are poised to raise interest rates faster than most people expected. The threat of central bank action is pushing up bond yields. This makes stocks relatively less attractive and is resulting in some violent market action as investors recalibrate their forecasts. It is not, however, reason to panic.

Barring war in Ukraine, a vicious new COVID-19 variant or some other new calamity, stocks still seem firmly in touch with reality. Aswath Damodaran, a finance professor at New York University and widely followed authority on stock market valuation, recently published his estimate of the intrinsic value of the S&P 500 Index, based upon figures as of Jan. 1. He calculated the benchmark should be trading around 4,320.

On Monday, after a day of big losses and an even bigger recovery, it finished at 4,410, up a fraction of a percentage point on the day. More volatility may be in store. But disaster appears unlikely.