Stock Market Correction, Or New Bear Market Unfolding?
IN THIS ISSUE:
1. OK, Stocks Have Plunged, Let’s Look at the Reasons Why
2. Increasing Worries About a Serious Global Trade War
3. IMF Unexpectedly Scales Back Estimate of Global Growth
4. Last But Certainly Not Least – 10-Year Yield Spikes to 3.25%
5. Morgan Stanley: 3% on the 10-Year Note is “Tipping Point”
I had a completely different topic in mind for today than what follows. In light of what has happened in the stock markets over the last two weeks, I feel the need to address that issue today. While this down move has so far been only a 7% stock market correction, I sense a lot of anxiety on the part of investors.
I’ll discuss the main issues the financial media is focused on as the cause of the latest selloff, and add my thoughts on whether those issues make sense or not. And I’ll share what I feel is the main reason for the latest market correction. Let’s get to it.
OK, Stocks Have Plunged, Let’s Look at the Reasons Why
On Wednesday, October 3, the Dow Jones Industrial Average soared to yet another new all-time record high just above 26,950 but then retreated to close well below the record high that day. The Dow then traded sharply lower on the following Thursday and Friday, dragging equity markets around the world lower with it.
The sharp decline continued last week with the Dow plunging to a low just below 25,000 on Thursday, a loss of about 7% from the high before rebounding modestly on Friday. So far this week, the market continued lower on Monday but is up several hundred points in the Dow so far today.
As always, market analysts tried their best to explain what was a most unexpected downdraft in the market. Here’s a summary of the major factors that led to the stock market plunge over the last two weeks.
Increasing Worries About a Serious Global Trade War
More and more US companies are voicing concerns about President Trump’s threats to engage in a more serious trade war and the potential negative impacts it could have on their businesses and earnings.
President Trump has said recently that he likes trade wars and that they are “easy to win." Yet Trump’s trade tariffs will make prices rise for American consumers, and this will not be good for our economy over time.
Mark Haefele, global chief investment officer at UBS Wealth Management, warned last week: “U.S. equity markets have been resilient to rising trade tensions compared to their global counterparts, leaving them susceptible to pullbacks as the costs become more apparent." And of course, China is reacting with trade tariffs of its own.
IMF Unexpectedly Scales Back Estimate of Global Growth
The International Monetary Fund cut its forecast for global growth last week, blaming rising trade tensions and stress in emerging markets. The IMF cut its global growth forecast for this year and next from 3.9% to 3.7%, specifically citing concerns about a trade war. The IMF also downgraded its estimates for the US economy in 2018 and 2019 to 2.9% and 2.5%, respectively.
While this year’s 19% gain in crude oil prices gives some economies a boost, the International Energy Agency has warned that high prices due to falling supply from Iran and Venezuela are leading to a “risky situation” for the global economy. Stocks didn’t like this news.
While the macroeconomic picture is still solid, especially in the US, concerns are growing that we’re moving into the later stages of the business cycle. Put differently, there are growing worries that we may be approaching a synchronized slowdown in the global economy – even though there are few clear signs of that yet.
Investors Change Market Priorities: What Was Down Is Up
The latest market sell-off has seen investors rotating into previously overlooked styles or sectors and discarding old favorites, thus hitting index funds’ favorite stocks the most. Quantitative investors are moving into value stocks and out of momentum and growth stocks, since cheap shares tend to do better when interest rates are rising.
There’s also been a rotation away from cyclicals and into defense stocks. Let’s consider the beloved US tech stocks. They’ve been battered during this latest sell-off, tossed aside amid the shift from growth stocks and a delayed reaction to trade uncertainty.
It will take time to see how all this works out. All these moves are compounded by heavy redemptions in passive funds and quantitative trend-followers. With bonds and stocks falling in tandem, redemptions from “risk parity” funds – which often invest in more asset classes than just stocks and/or bonds – are also contributing to the selloff.
Italy Sticks to Its Guns & Is Still a Big Concern
In Europe, the equity slide came a little less abruptly, as worries over Italy’s debt sustainability have been weighing on markets for a while now. The country’s populist leaders are sticking to their big spending and costly election promises, even as sovereign yield spreads continue to widen.
Italy’s benchmark stock index was already in a bear market before the latest market rout, having plunged 20% from its peak in May. For the rest of Europe, the fear is that Italy could spark another financial crisis that could send the EU into a recession just ahead. This added fuel to the latest market selloff.
Last But Certainly Not Least – 10-Year Yield Spikes to 3.25%
In my view, the most important reason for the latest market correction is the fact that the US 10-year Treasury Note yield surged to the highest level since 2011 over the last two weeks, and did so very rapidly. The yield jumped from around 2.8% in mid-September to 3.25% this month. It is back down to 3.16% today.
Federal Reserve Chairman Jerome Powell recently heaped praise on the American economy, stoking expectations that monetary tightening will continue. While higher rates haven’t interrupted US stocks’ broad uptrend so far, they may have crossed a threshold where they’re starting to weigh on pricey stocks and make equities less attractive in general.
In addition, on Thursday the Consumer Price Index came in a bit lower than expected at 0.1% in September, and an annual rate of only 2.3%. The trend in inflation will play a key role in setting Fed monetary policy going forward.
Morgan Stanley: 3% on the 10-Year Note is “Tipping Point”
Michael Wilson, the chief equity strategist for Morgan Stanley, says the 10-year Treasury yield marking new highs last week was the tipping point for the stock market. Put differently, he believes that if the 10-year yield rises much above 3%, it will be hard for the stock market to continue higher.
Wilson had warned earlier this month that the stock market had become overvalued for the first time since January. This overvaluation was apparent as yields on the 10-year Note broke through the 3% barrier. Wilson pointed out that small caps had already been underperforming for several months, and when rates moved above 3%, their underperformance accelerated.
With last week’s surge above 3.20%, weakness finally came to the high-flying growth stocks where valuation is the most stretched. Wilson said he was not surprised by the correction in stocks; he was surprised, however, by the speed at which the rise in the 10-year Note occurred (as discussed above).
Wilson has been recommending investors avoid the areas of relative strength in global equity markets, like US small caps, tech and consumer discretionary shares, essentially recommending value stocks over growth stocks on a global basis.
It will be interesting to see if the 3% or above level in the 10-year Note will act as a ceiling for the stock market. We know, for example, that the Fed intends to raise the Fed Funds rate four more times between now and the end of 2019. That would imply a 10-year Note yield well above 3%. We’ll see.
Gary D. Halbert
Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.