Are we witnessing a new collapse in US equity markets, a Bearish reversal or just a correction?Posted on Monday, February 12 2018 at 5:38 pm GMT+0000
Last week, the Dow Jones closed 10% lower and S&P closed 9% down.
Before starting to analyze whether that decline is a bearish reversal, a probable collapse or just a correction, let’s explain the difference between the three scenarios.
A collapse is a sharp and hasty decline where losses exceed 20%. This was a common factor between the Black Tuesday on 1929 and the Black Monday on 1987, the Dot Com bubble in 2000 and the 2008 crisis.
In a Bearish reversal, losses also might exceed 20% and with a sharp or rapid pace, especially if markets were at extreme overbought levels.
So the current facts indicate that the markets are in the corrective stage which is normal, especially since prices have not seen any actual correction since November 2016.
That correction can extend turning the overall market bias to Bearish in the long term, especially with most countries tending to tighten their monetary policies either by reducing their QE programs or by raising interest rates, where bonds begin to offer a higher and safer return for investors, thereby curbing demand for stocks.
But the persistence of good fundamentals and the absence of volatility in the Forex and gold shows no major concerns among investors and reinforce the likelihood that the recent decline in equity markets will be just a corrective stage.
Only Dow Jones dropping below 23000 and S&P below 2500, can signal that the market is entering a bearish phase, which means a sustained decline in equities prices and a rise in gold and safe havens such as the Yen prices.
What is certain now is that we have entered a new phase characterized by high and the stability we were witnessing last year is over.
The recent underperformance of US equities is being attributed to the continued surge in US Treasury yields. As yields rise, bonds begin to offer a higher and safer return for investors, thereby curbing demand for stocks.
The declines were exacerbated by inflationary pressures on Friday after the US Nonfarm Payrolls report showed wage rises to their highest level since the global crisis in 2008.
That could result in a “spike” in interest rates; higher interest rates higher bonds yield which will then form a good alternative to equities.
This week the focus turns to inflation data from Japan, UK, US and New Zealand, but the most important of course is the consumer price index from the United States due on Wednesday, and a better than expected reading will exert greater downward pressure on equities.