After Monday’s rout on Wall Street, the same people who were asking if the near-term pain was behind us as stocks rallied into quarter end last Thursday will probably be tempted to ask something similar on Tuesday assuming the bottom doesn’t fall out immediately.
The answer to that question (i.e. whether the near-term pain is mostly behind us) is probably “no” and not necessarily because we’re predisposed to bearishness or otherwise prone to always saying “no” when that question is asked.
Rather, the issue here is that with the possible exception of tighter financial conditions engendered by higher short-term funding costs, none of the problems markets face are what one might call “temporary” in nature. Regulatory concerns in tech are going hang over the space for months and probably years and there’s no telling how long Donald Trump will persist in attacking Amazon. Multiples (forward P/E) in big-cap tech are still stretched versus the broad market and while you’ve got to pay up for growth, inflated valuations could still prove to be an impediment to a rebound in the sector if the headwinds don’t abate:
As for the trade tensions, well, barring some kind of dramatic shift in the rhetoric from the Trump administration, that’s going to take months and months to play out and indeed, that’s probably the point. If this a mid-term gambit designed to bolster the GOP ahead of November, Trump needs to keep this conversation going so he can continually crow about “getting tough” and “America first”.
The fact that those clouds (tech, trade, and Trump or, “the three Ts” as we called them in our week ahead preview) are likely to linger is perhaps the best reason of all to be bearish in the near- to medium-term, but if you want a more exhaustive list, Bloomberg’s Mark Cudmore has one for you.
Additionally, what you’ll read below is infused with a bit of Cudmore’s characteristic long-term optimism, so it won’t leave you feeling too sour to start the day.
U.S. equities losses are far from over but that’s not necessarily a warning that the economic cycle is turning.
- While recent volatility may seem excessive, such a stock market correction is not only to be expected, it’s arguably overdue
- The S&P 500 has had three peak-to-trough pullbacks greater than 15% in the past eight years. The last one ended in February 2016 and formed the base for a 59% rally in less than two years. In 2011, the benchmark index plunged almost 22% before bouncing back to finish that year unchanged
- At its deepest, this year’s drawdown was a relatively tame 11.8% and all the drivers of the current correction remain completely valid, suggesting that a medium- term low isn’t close to forming yet
- Trade tensions and tech woes will take weeks to play out. There’s still a liquidity-squeeze from higher front-end U.S. yields and the widening Libor-OIS spread. VIX Index moving averages continue to climb, forcing further deleveraging. The credit cycle has turned into a headwind rather than a tailwind for corporate funding. Commodities weakness, and what that says about global growth, hasn’t yet been adequately reflected in equity outlooks
- Even though global growth momentum is showing clear signs of decelerating, there are few reasons to fear a recession on any near-term horizon. Second half of 2018 is likely to see equities perform well again, even if it is not a repeat of last year’s extraordinary low-volatility rally
- Before such an ascent can recommence, we need to see greater progress on the three prerequisites outlined in this column two months ago: More deleveraging; more bearish prognoses in the market; and much lower U.S. yields
- Ten-year U.S. yields at 2.5% should be treated as an alert to start looking for the next leg of the long-term bull market, not as a recession warning. By that time, many of the negative drivers will have fully played out and the S&P 500 will be trading at significantly lower prices