Key factors behind the selloff in markets

On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Research Analyst Emily Zhao explored the primary drivers behind the recent bout of market volatility. They also assessed the outlook for markets through the lens of cycle, valuation and sentiment, and chatted about the current state of the global economy.

S&P 500 approaches bear-market territory as selling intensifies

Addressing the recent tumble in markets, Eitelman noted that the week of 16 May was particularly rough for U.S. equities, with the S&P 500® Index declining by roughly 4%, as of market close on 19 May. "This latest round of selling on Wall Street dragged the benchmark U.S. equity index closer to a bear market, with the cumulative peak-to-trough decline for the S&P this year now at 19%," he stated, characterising 2022's selloff as both significant and serious.

The downturn in markets since the start of the year can be attributed to a few primary factors, Eitelman said, including Russia's invasion of Ukraine in late February, which sent commodity prices soaring. At the same time, inflation has continued to run at multi-decade highs, he noted, which has caused the U.S. Federal Reserve (Fed) to embark on an aggressive rate-hiking cycle as it attempts to tame pricing pressures by increasing borrowing costs. "The net effect of all of this has been rising anxiety over the prospects for a slowdown in economic growth - and these worries are really rippling across financial markets right now," Eitelman remarked.

The latest round of volatility was triggered by a few significant misses on corporate earnings results from some major U.S. retailers, including Walmart and Target, he said, with both companies noting that significant cost pressures are impacting profitability. In addition, the retail giants stated that inflationary pressures are causing consumers to cut back on purchases of big-ticket items, and to be more budget-conscious in their spending habits, Eitelman noted.

Market outlook: Business cycle vs. investor sentiment

Turning to the outlook for markets amid the ongoing turbulence, Eitelman said assessing U.S. equities through Russell Investments' framework of cycle, valuation and sentiment (CVS) highlights some pretty significant tensions. Cyclical concerns have increased as the business cycle rapidly matures, he said, which leaves him a little more cautious. "On the other hand, our contrarian indicator shows that market sentiment has become very pessimistic - and that's a pretty powerful tactical signal for us," he stated.

Ultimately, the competing signals within the CVS investing framework have led Eitelman and the team of Russell Investments strategists to maintain a balanced investment approach at the moment. "Right now, our preference is to stick to our long-term strategic asset allocation," he stated.

Are signs of weakness emerging in the global economy?

Amid the choppiness in markets, Zhao asked Eitelman how the global economy has been faring this year. Eitelman said that overall, the economy has been pretty resilient, but that some areas of weakness may be starting to emerge.

One of the more obvious pockets of weakness is in China, he said, due to the rise in COVID-19 infections that led to lockdowns in major cities like Shanghai and Beijing in March and April. The lockdowns led to some fairly significant economic impacts, Eitelman remarked, but with the COVID-19 situation improving a bit, expectations are increasing that Chinese growth could rebound in the second half of the year. "This could especially prove to be the case if the Chinese government enacts more stimulus measures," he noted.

Rising concerns that tighter Fed policy could tip the economy into a recession are also beginning to impact corporate confidence, Eitelman said, noting that U.S. CEOs have increasingly soured on the economic outlook. In addition, growth in the manufacturing sector - particularly in the U.S. - has started to step down a little bit from the very strong rates observed over the past few years, he stated. "In the U.S., we're seeing more middling growth rates now - but it's growth nonetheless," Eitelman remarked.

He said that the final area that's exhibiting a little bit of weakness right now is the global real estate market, due to rising mortgage rates. "The sharp uptick in rates is creating affordability challenges for many individuals, and this has taken a little bit of a bite out of real estate demand," Eitelman concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.