Sell-off Might Be More Severe Than Major U.S. Indices Suggest

February 3, 2022

Source: J.P. Morgan Equity Macro Research; Data from Jan. 1 to Jan. 27, 2022 Source: J.P. Morgan Equity Macro Research; Data from Jan. 1 to Jan. 27, 2022

Last week, equity markets were extremely volatile. The S&P 500 Index and Nasdaq Composite saw the largest point swings since the great financial crisis of 2007-08. Unfortunately, 2022 is not off to a great start, and the S&P 500 Index's significant drawdown in the first few weeks of the year was one of the worst on record. The stock market’s recent roller-coaster ride was headed toward bear market territory. What’s more amazing is that the performance of the average stock in each of the major indices was even worse than what the benchmarks have experienced.

In this week's chart, you can see the equity market sell-off across different indices versus the average stock drawdown within each index. It is important to note that the stocks in these broad indices are assigned weightings based on market capitalizations and each index is heavily influenced by the largest-cap stocks within it. As a result, based on the average stock, the sell-off has actually been more severe than the broad index performance numbers would suggest.

This week's chart shows that the drawdown of constituents is much worse across the board. This is especially true for the Nasdaq Composite, which is one of the broadest market indices and includes more small-capitalization companies. The biggest market-cap stocks like Microsoft, Apple, Amazon and Tesla are certainly keeping the indices from sinking further. It is not surprising to see these differences as small-cap stocks have been getting crushed recently, as seen in the Russell 2000 Index. Keeping this chart in mind may tell us that the health of the overall stock market could be shakier than observed at first glance.

Per my research, it seems company valuations have become so high that earnings and sales in most cases have not been able to keep up. Valuations are proving to be inflated, as many companies are meeting or exceeding earnings expectations but seeing their stock prices barely move. The market reactions suggest that current valuations have already priced in these increased earnings and sales. Further, any type of negative guidance or slight miss on earnings has generated a poor market reaction, which could partially explain why we are seeing this sell-off.

Key Takeaway

This week’s chart highlights how the recent sell-off from an index perspective could be slightly misleading. The drawdown in the indices versus their constituents is sizable and shows how the broader market could be struggling even more looking below the surface. Despite these negative results, it is important to always go back to the basics and stay focused on the fact that individual security selection is pivotal. I believe finding good companies with good balance sheets and good management teams will continue to be the key to a successful investment process.    

Tags: Volatility | Equity markets | large-cap stocks | small-cap stocks | NASDAQ

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