Stock Market Sell-off: Correction in the Cards or Something Worse?

by the Curmudgeon


Perspective & Analysis:


U.S. stocks suffered their biggest losses since February 2014 on Thursday.  After being above 2100 Tuesday morning, the S&P 500 closed down 2.11% at 2035.73 today.  The tech heavy NASDAQ 100 was off 2.77% on the day, while the small cap Russell 2000 was off 2.53%.  The riskiest growth stocks tumbled hardest.  Blackstone Group was down 10.7%, Arista Networks gave up 6.85%, while the iShares Biotechnology ETF (IBB), one of the best-performing sectors in recent months and years, lost 4.1%.


The S&P 500 closed 38 points below its 200-day moving average, with its 50-day moving average now only 15 points (from a death cross) below its 200-day moving average.

That's a pretty big 2 ½ day decline with no real fundamental economic news as the catalyst.   While the fall is generally attributed to weakening global growth (especially China)…..


“Not only is there an excess of oil globally, but China’s slowdown is driving a collapse in commodity prices. It has hurt many countries whose economies are based on oil, metals and agriculture,” writes CNN Money. “The commodity bust is bad news for the economic outlook for several countries and the American companies that do business there.”


But that's not new at all!  It's been reported for months that China's economy was slowing, its exports are way down (see last section below), stock market on the ropes and IMF has delayed considering the yuan for reserve currency status.  The time for a market reaction to any of those events was weeks ago—not today!


Moreover, commodities, emerging market (EM) currencies and stock markets have been declining for months!  EM equities tumbled for a fifth day running on Thursday to their lowest level since 2011.  


Yet up until this Tuesday, none of that phased the U.S. stock market.  Nor did the never ending soap opera in Greece (which continues as PM Tsipras has just called for a snap general election).


-->The key point is that when an asset class (like U.S. equities) is way overpriced, it doesn't take much to precipitate a large daily decline.  Think of it as an inflated bubble that pops on its own without a prick!


Other Voices:


“It was a terrible day,” said Brian Jacobsen, a strategist at Wells Fargo Funds Management. “In the past, sell-offs have tended to start in the US or Europe and then spread to emerging markets, but now the feedback loop seems to have reversed.”


Courtesy of Barron's (on-line subscription required), here's a note from the institutional trading desk of a major Wall Street bank (not identified):


“It was as ugly a session as this market has seen in a very long time. The selling Thursday was relentless but steady and not urgent or panicked; buyers however were completely absent and never tried to make a strong stand. While the price action lacked emotion, there was definite pain and signs of risk being brought lower regardless of whether a specific ‘reason’ was present or not. The room actually grew eerily quiet in the day’s final hours (as stocks hit their lows things actually became calmer).


Trying to fundamentally explain the swoon is difficult. ‘Growth is slowing; has underpinned the sell-off for days and while there is certainly evidence to bolster those fears there was barely any economic data out in the last 24 hours. China increasingly has become ground zero for the negativity narrative:  ‘growth is slowing officially,’ ‘growth is slowing even more than the official statistics suggest,’ ‘China can’t control its markets,’ ‘China is going to spark a wave of competitive devaluations.’  A lot of the growth/China commentary is hyperbole but in a news vacuum the meme is able to expand uncontested.


The Fed is the one ‘change’ in the macro landscape in the last 24 hours and if blame has to be apportioned for the Thurs carnage, it prob. belongs w/the [Fed] minutes [released on Wednesday]. This is a tape that craves liftoff – the uncertainty around the first hike is paralyzing sentiment and after the minutes on Wed it looks like this overhang could last until December at least.”


David Greenberg, President of Schaeffer Greenberg Advisors, thinks today’s drop could be the start of a serious stock market correction, rather than a dip worth buying.  Underlying his concerns are what he views as a fragile U.S. economy and an uncertain political outlook.


He writes that the economy is “built on artificially low interest rates and earnings growth derived from firing employees and cutting costs — not from producing and selling more products. The political outlook makes it worse: There is no one (from either side) standing out as someone who understands real fiscal policy.”


Greenberg adds a warning to dippers: “I am not concerned about this short-term sell-off, but I am deeply concerned that the market is setting itself up for a major and long overdue correction.”


In a blog post today, Yahoo Finance columnist Michael Santoli cites data from Barclays Capital stating that “more than $90 billion has sought the shelter of money-market funds in the past six weeks. That’s roughly the same magnitude of flight response seen in other risk-off spasms of the past four years, from the 2011 Euro debt crisis, the fiscal cliff drama of 2012 and the taper tantrum in 2013,” he wrote.


Richard Russell, the granddaddy of all market newsletter writers reports that his PTI (Primary Trend Index) is below its 89-day moving average.  In a note to Dow Theory Letter subscribers today, Russell wrote:


“I believe the stock market has gone bearish; subscribers should stay with their position in physical silver and gold. Gold is a friend of free markets and the enemy of central banks and their fiat money. Rejuvenating a sick economy by creating more currency has never worked, and it won't work this time.”   To explain why, he wrote:


“1. I believe the US economy is sinking into recession as described by John Williams of Shadow Stats. I believe we are in a period of deflation and deleveraging. I am convinced that the Fed knows the economy is contracting and this is the reason that they have not yet raised rates.

2. There are now ten distribution days in the S&P and four in the Nasdaq. Thus it is clear that many institutions are stepping to the sidelines. A combination of ten distribution days in the S&P and four in the Nasdaq comes to an ominous total of 14, and it puts the market under pressure.”


Curmudgeon's Greatest Fear: China Triggers a Global Recession


·        China's exports declined much more than expected in July, hobbled by a strong yuan and lower demand in the European Union.   Exports fell 8.3% from a year earlier in dollar terms which was well below the estimate for a 1.5% decline in a Bloomberg survey.  Exports also fell unexpectedly (by 6.4%) in April from a year earlier.

·        Imports into China have been falling for much of this year, a sign of declining domestic demand as the world's #2 economy slows.  April imports tumbled 16.2% from a year earlier, following a 12.7% drop in March that highlighted tepid domestic demand.

·        Car sales growth in China has dropped sharply this year, weighing on the earnings of global automakers.


·        The slowdown in China’s economy has pushed down global commodity prices, especially those used in heavy industry such as iron ore, copper and oil.


·        That, in turn, has undermined growth in the resource-rich emerging markets that export to China, including Brazil and Russia, both of which are in recession.  


·        The knock-on effects of the commodity slide have been felt in Asia’s high-end manufacturing economies, notably South Korea and Japan, where cuts to investment by miners and energy producers have hit the large engineering companies that supply drilling platforms and gas storage units used in resource extraction. Many countries in Latin America (e.g. Mexico and Chile) have also been hit hard by the rout in oil and commodities.


In conclusion, we think that China poses by far the greatest risk to the U.S. (and all other) equity markets, as its continued economic woes might lead to a global recession.  If that was the case, it would certainly result in a bear market for global equities.   Has it started yet?  Watch China!

Till next time…


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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