Stock Market Remains In Correction Mode

Foreword from ShareInvestor

This article “Stock Market Remains In Correction Mode” by Rob Curran was first published in The Business Times on 18 Jun 2018 and is reproduced in this blog in its entirety.

Economists are looking for signs that one of the longest economic expansions on record is ending

After flirting with new highs earlier this month, US stocks are back on the skids, with worries about rising interest rates and slowing global trade overshadowing strong domestic data.

Following its biggest weekly decline since March, the Dow Jones Industrial Average closed just above the 25,000 level last Friday.

While the Dow is still much closer to its January highs of around 26,000 than its March lows around 23,000, last week’s action made it clear that the stock market remains in correction mode nearly five months after the peak.

The losses started mounting last Wednesday after the Federal Reserve issued an unexpectedly hawkish statement.

Fed chairman Jerome Powell and the Fed’s rate-setting committee stated that the economy was humming along, stoking inflation and making it likely that two more rate hikes would be needed by December.

The sell-off intensified for industrial and commodities companies later in the week as hopes that China and the US would back off tariff threats faded rapidly.

After a series of mixed messages, the US said it would, after all, levy duties on US$50 billion worth of Chinese imports, many of them technology products.

Beijing responded in kind, vowing to impose tariffs on agricultural, energy aIntnd other American imports. Last Friday, the price of soybean futures fell to the lowest level in a year.

While the soybean sales are not a major part of the US economy, they have a far-reaching significance. Small farming communities spread out over vast swathes of states like Texas and Georgia count soybeans as their most important crop.

It’s in these kinds of communities where US President Donald Trump’s following is the most ardent. China is trying to hit Mr Trump where it hurts – in the red states.

Some economists say that the severity of the slowdown in global trade in the 1930s, one of the primary macroeconomic symptoms of the Great Depression, was a result of similar protectionist measures in major nations including the US.

Some of Mr Trump’s advisers, including Treasury Secretary Steve Mnuchin, are thought to oppose tariffs. If the two sides are to pull back from a damaging trade war, the first signs of a peaceful resolution will have to emerge soon, or the damage will be done.

“What will be interesting now is the response from the White House,” said Quincy Krosby, chief marketstrategist at Prudential Financial. “If they can sit down and continue negotiations, that’s what’s paramount for the market.”

The longer the tariff threats remain in place, the harder their negative effects on economic growth will be to undo.

“What we are hearing from business owners is that they are postponing their plans for hiring, their plans for expansion because of the uncertainty,” said Ms Krosby. “That kind of uncertainty can hover over the economy and in many ways negate the positive effect from the tax cuts.”

Rising interest rates are another headwind for the stock market and the economy.

After periods of declining rates like the last decade, the increase in borrowing cost is akin to someone flicking on the lights after a wild party. The excesses and debilitation of some of the guests suddenly become impossible to hide.

This time around, the speculative excesses of bitcoin came to light as did the unstable condition of Argentina’s currency.

Last Wednesday’s Fed statement only heightened the pressure on these markets. Bitcoin prices are trading near their lowest levels of 2018, around US$6,500, a full two-thirds lower than their January peaks.

“Since the Fed moved into its more deliberate tightening campaign in the fourth quarter of 2017 – arguably a regime shift – we have been experiencing ‘pop-up’ thunderstorms in what I would call the weakest links in the capital markets, starting in December with perhaps the most speculative asset class of all, cryptocurrencies,” said strategists at brokerage Morgan Stanley in a research note.

Lorenzo Di Mattia, a manager of hedge fund Sibilla Global Fund, has been awaiting a big market storm for much of the last 12 months. Until recently, he had not detected the dark clouds of financial stress that typically precede a market hurricane.

“Italy and emerging markets are experiencing moves that historically were associated with big corrections – I refer to moves in sovereign bond spreads, credit-default swaps and foreign exchange,” he said.

As Mr Powell observed, the US economy is growing at a torrid rate, for now. But economists are looking for signs that one of the longest economic expansions on record is ending.

This week, housing data could extend a recent pattern of slowing home sales. The spillover effects of currency crashes in Argentina or other emerging markets could spill into the US stock market.

Above all, investors will be watching the game of chicken that Mr Trump and his Chinese counterpart Xi Jinping are playing with the global economy.