How to Spot the Signs of a Stock Market Sell-Off
If you’ve been checking up on your portfolio in 2022, you’ve likely seen a concerning trend. The S&P 500, alongside other key indices is down more than 12% this year, after peaking on January 3. Markets shed considerable value throughout February, and continue to drop in March, prompting financial analysts to begin calling the pullback what it is: a stock market sell-off.
Stock market sell-offs aren’t an anomaly and, strictly speaking, can be healthy for stabilizing markets. Nevertheless, investors are spooked by this latest bearish manifestation because it comes on the heels of several major headwinds that are poised to persist.
Here’s a closer look at what a stock market sell-off is, why they occur and what’s driving the current bearish downtrend in 2022.
What is a Stock Market Sell-Off?
As the name implies, a sell-off occurs when investors begin to exit their positions and trim their portfolios en masse. Previously bullish sentiment turns bearish and share prices tumble down from recent highs. And while it’s relatively common for sell-offs to affect individual stocks, a broad sell-off occurs when investors sour on the stock market as a whole.
Sell-offs are a largely psychological event when they affect individual stocks. For instance, of a company falls short of earnings expectations, the sell-off is likely the result of misaligned expectations. Pending good news, the company is likely to bounce back because its intrinsic value hasn’t changed.
Sell-offs that affect the entire market are a different animal. While they represent a pessimistic outlook on markets, they tend to have roots in quantifiable struggles. These sell-offs start fast and, pending socioeconomic conditions, can become catalysts for corrections as markets continue to sink.
Common Signs Surrounding a Stock Market Sell-Off
Like most stock market patterns, a sell-off isn’t possible to predict with any degree of certainty. The most investors can hope for is to recognize one as it’s happening. Here are four of the key indicators that become prevalent in broad market sell-offs:
- High market multiples. When companies seem “expensive” or sectors seem like they’re “in a bubble,” it’s cause for concern. Investors looking at core valuation metrics (P/E, P/S, P/B) will shy away from companies that sell for magnitudes of order more than the intrinsic value of the company, especially when economic uncertainties loom.
- Federal reserve action. Dovish monetary policy can help assuage fears during times of economic strife. When the time comes to raise interest rates or pull back on quantitative easing action, investors often respond by taking profits.
- Flattening yield curve. When the yield curve flattens or goes inverse, it’s a sign that future confidence is waning. The yield curve is typically regarded as one of the best indicators of major market pullbacks: correction, crash, recession and depression. Market sell-offs go hand-in-hand.
- Global economic events. While many investors are fine to weather domestic economic uncertainties, far fewer stand tall in the face of global struggles. Black Swan events are almost always a catalyst for market sell-offs.
There tends to be a murmur of underlying factors that prime markets for a broad sell-off; then, a catalyst or series of catalysts that kick off the downtrend.
What’s Causing the Current Market Sell-Off?
Investors wondering why their portfolios have dipped significantly in 2022 need only to look at a few headline factors to understand the precursors to this particular stock market sell-off. Here’s a quick peek at why markets are dropping and likely to continue dropping in the near-term:
- Supply chain bottlenecks. Specifically, the world’s semiconductor supply chain faces bottlenecks at multiple points. Semiconductor chips are vital for production in many major industries, which is grinding tech, automotive, aerospace and other major sectors to a halt.
- The Russo-Ukrainian War. While your defense stocks might be soaring right now, it’s likely most other sectors in your portfolio are down. Not only does the war disrupt a major trade route through Eastern Europe, it further exacerbates semiconductor supply chains. Ukraine and Russia are the world’s leading producers of neon gas and palladium: two materials essential for production.
- Rising interest rates. After dovish monetary policy to help posture the economy during the COVID-19 pandemic, the Federal Reserve is set to hike interest rates again. Traditionally, rising interest rates correlate with a deflation in stock prices. Even though this rate hike has yet to pass, the current stock market sell-off is an indicator that it’s likely to.
- The Great Resignation. Worker shortages are becoming more and more of a problem for companies. As a result, staffing struggles have begun to manifest in operational deficiencies. As companies report earnings below expectations or struggle to maintain projections, investor sentiment turns from bullish to bearish. And as hiring remains a struggle, bears will begin to creep into the markets.
These are far from the only factors pushing markets into a sell-off. They are, however, the largest contributors to the persistent struggles may investors are bearish on. As these problems persist, so will the sell-off.
How to Navigate the Sell-Off
According to Jacob Manoukian, U.S. Head of Investment Strategy at J.P. Morgan, navigating the current stock market sell-off takes a forward-thinking approach. Instead of focusing on the red in your portfolio right now, start planning ahead with a mind for making small adjustments.
Liquidating your holdings to take small gains is largely reactionary, and likely to leave you in a worse position. On the flip side, buying low isn’t recommended until the market stabilizes. While the risk-reward outlook is different for every person, the market’s current trajectory demands discipline.
The bottom line? Take profits where it makes sense, offset with capital losses and identify the safe haven assets in your portfolio where there’s opportunity to preserve wealth amidst a market that’s set to become more volatile the longer the sell-off continues.