The S&P 500 experienced a sharp move lower last week as investors became more cautious. It culminated in the index dropping below a key psychological level on Friday after a 0.88% decline. The S&P 500 closed 43.89 points lower during Friday’s session.
However, analysts at Wells Fargo provided their thoughts on when the sell-off may end in a research note to clients on Monday.
S&P 500 falls below 5000
Last week's market correction intensified on Friday, with the S&P 500 finally breaking below the psychologically important level of 5,000. This drop capped a week of selling, fueled by several factors.
Hotter-than-expected inflation in March raised concerns about persistent inflation and the Federal Reserve's response. Investors worried that the Fed may delay a potential June rate cut, while inflation could dampen economic growth.
Geopolitical tensions, particularly the recent flare-up between Israel and Iran, added another layer of uncertainty to the market. Investors tend to seek safer assets during periods of international instability, pulling money out of stocks.
Finally, the so far mixed reaction to earnings releases has also provided some volatility. The negative sentiment continued into Friday, with even profit beats from Procter & Gamble (NYSE:PG) and American Express (NYSE:AXP) failing to stem the tide. The breach of the 5,000 mark could trigger further technical selling.
Wells Fargo on what comes next
In its client note, Wells Fargo explained that history suggests the rise of the near-term volatility index (VIX) is likely to continue.
The investment bank stated that Friday “felt like a classic hedge fund de-grossing, with a sell-off in Tech/ Momentum while higher-risk small caps (IWM ETF, often used for short exposure) was up in a down tape.”
While some are calling for a rotation, Wells Fargo believes it is more about selling/de-risking the momentum trade rather than demanding liquidity in value and financial shares. It is felt that the near-term setup for financials seems uncertain with a less-dovish Fed.
Regarding earnings, Wells Fargo notes that in the quarter-to-date, there has not been much in the way of new news.
“The consumer is still selective and value-oriented,” wrote the bank. “High-end consumers appear better off than the low-end. For banks, there are concerns about NIMs vs expectations as anticipated Fed accommodation resets and depositors seek higher yields. The digestion of post-pandemic goods gorging seems to continue.”
While positive results this week could aid markets, Wells Fargo is “confident the VIX windup is not yet over yet — and neither is the sell-off.”
“We have been surprised equity volatility and the VIX have been so well-behaved YTD, especially with rising rates and geopolitical risk,” added the bank. “Our late-2023 analysis suggested we would see a VIX spike in 1H24 and slight equity downside.”
While it is unclear if the SPX will go negative for the year, the bank’s analysts feel that the sell-off likely ends when the VIX reaches the low/mid-20s.