Expert Warns of 30% Drop After Tapering Starts

Stocks face mounting opposition as fears of stagflation build, Lance Roberts said. Roberts is warning

  • Stocks face mounting opposition as fears of stagflation build, Lance Roberts said.
  • Roberts is warning about a potential a 30% pullback ahead. 
  • He said Fed tapering would likely be the cause. 

After the stock market’s first 5% pullback in about a year, Lance Roberts likes the outlook in the near term.

But beyond a few months, things are looking bleak, the RIA Advisors chief strategist said in an October 12 note and reiterated in a call with Insider on Friday. 

He cited a number of indicators. 

From an economic standpoint, growth rates have peaked and the outlook is lackluster ahead, he believes. Job gains are slowing as more people leave the workforce, and manufacturing has headwinds amid supply-chain bottlenecks. Then there’s fiscal and monetary

liquidity
starting to dry up, as well as earnings growth looking small compared to early 2021 numbers. 

With inflation also high, Roberts said there is a credible threat of stagflation, the much-feared combination of inflation without the robust economic growth that should come with it. 

This would put stocks in a corner, Roberts said. Stagflation would hurt stocks, which are currently priced to reflect higher expected earnings.

“Earnings estimates are way too high,” Roberts said. 

Mike Wilson, the chief US equity strategist at Morgan Stanley, also sees earnings estimates coming down and dragging stock prices with them. Earnings revision breadth, the difference between analysts’ upgrades and downgrades, is on course to fall as the third-quarter earnings season continues. “We see higher labor and raw material costs, supply chain issues, and demand pull forward being key risks,” he said in a recent note.

But tightening from the Federal Reserve to crush stagflation — in the form of hiking rates and shrinking the amount of assets they purchase more swiftly — would also deliver a blow to stocks, who thrive on the higher liquidity the Fed provides, according to Roberts. 

Within the market, prices have approached their “sell-signals” on RIA’s proprietary risk management indicator. It’s hit the top of the

bull market
trend channel, and its short- and long-term risk indicators have started to turn south, dipping under the buy/sell signal for the first time since March 2020 when the market bottomed following a 35% sell-off.

risk management indicators



RIA Advisors


 

For the top section of the above chart, Roberts said stocks could fall 30% without breaking the long-term bullish trend. 

He added that, most likely sometime between March and June of 2022, stocks would see a pullback between 15-30%. It would be caused by the Fed tapering asset purchases from their current rate of $120 billion per month. 

“There’s a point in the tapering where you extract too much liquidity from the markets through the taper,” he said. “In November, December, January, they taper — you’re still doing $105 billion, $90 billion, $75 billion…I don’t know exactly what month it is, but probably sometime between March and June next year we could see this market down fairly significantly.”

Roberts’ views in context

Roberts’ warning that stocks could crash up to 30% is not far out of the realm of mainstream views on Wall Street. 

Morgan Stanley‘s Wilson recently said that stocks could suffer a 20% pullback in the months ahead, and Deutsche Bank’s Parag Thatte said this week that stocks could drop 11%.

With some weak economic signals such as slower job growth, investors are also beginning to worry about stagflation. And their concerns may be warranted. Experts like Nouriel Roubini, Francois Savary, and Nancy Davis have all warned of the phenomenon taking hold.

“The reason it’s so bad for corporate America is that it means higher expenses and less profitability, less earnings-per-share growth,” Davis, who manages the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL), told Insider this week. “There’s a lot priced into credit and equities on the corporate side, there’s a lot of growth expectations.”

However, many major Wall Street institutions this week — like BlackRock and Goldman Sachs — have said stagflation fears are too overhyped. This is because they expect robust economic growth ahead, and inflation to eventually cool off.

But Roberts thinks their expectations are too rosy. And it’s anyone’s guess what happens when the Fed begins to reign in the vast liquidity that has propped up markets since early 2020.

RIA’s risk management indicators certainly don’t paint a pretty picture.

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