Fri, JAN 24th, 2014
With equity markets turning sour this week investors have two real choices: 1) PANIC, or 2) breathe.
At this point we don’t yet have a “correction” on our hands. A correction is generally defined as a -10 to -19% sell-off in the market [bear markets are -20%+]. The current -3% is barely akin to a pull-back [defined as -3 to -9%]. But is this pull-back setting up to be a full-fledged correction? Maybe. Maybe not. Either way, I believe this recent selling is chiefly predicated upon a few items:
1) Recent news out of China [a January PMI that missed the mark; SEC battles with the Big-4 US accounting firms’ Chinese arms; and a ~$496M Chinese trust investment on the brink fanning the flames of systemic debt fear, probably the largest cause of recent anxiety]; and also the rocky emerging market currency behavior of the past couple of days [Turkish Lira, Argentine Peso — both suffering from policy problems, but the latter is experiencing dollar-reserve issues as well]. Taken together, this recent volatility and uncertainty in emerging markets and their currencies are impacting sentiment on U.S. stock markets.
2) Given the increasingly accepted general outlook for 2014 that the U.S. economy is getting better and that the Federal Reserve is on track to normalize monetary policy, rates seemingly have nowhere to go but up. Thus a major related undercurrent in the marketplace in recent months has been — in classic Wall Street fashion — traders overplaying their hand, this time on the short side of the U.S. Treasury market. To wit, short positions in this market have grown quite large, according to data from Stone & McCarthy Research. As a result it appears that, following a big run in the stock market and a big sell-off in the Treasury market, weaker-than-expected Chinese PMI data and a potential credit flap were enough to trigger a flight to quality back into safe haven assets. This lead to serious short-covering in Treasurys and sent markets spinning. This hedge fund driven market flush scenario is of course but a theory, though it’s one that seems to make sense when looking at recent price action and correlations.
Indeed, this was probably needed after such an impressive rally.
By my count, over the past twelve months we’ve had three different notable pull-backs while the market has moved roughly +30% higher. Each one had their reasons, so to speak, and I don’t see anything out there that suggests that this one is somehow more concerning or fundamentally different from the others. So, how long does this one it last? I don’t know. How low does it trade? Haven’t a clue. Nevertheless it’s worth noting that the majority of the recent pull-backs have been both short and shallow. This is likely a function of money wanting to get into stocks after years of receiving negative real returns in cash and paltry yields in fixed-income. Stocks have crushed other asset classes for nearly five years in spite of rampant fear and loathing; suffice to say, those under-invested used those dips as buying opportunities. Unless we see some grave deterioration in economic fundamentals, I suspect this time is no different.
So, how are we handling this pull-back? For now, we are prudently and carefully watching from the sidelines. We aren’t selling into it. Our macro baseline for both the US economy [it’s doing OK and growth is broadening out] and the stock market [we’re still in a bull market that’s going higher] remain firmly intact. We are closely watching U.S. corporate earnings season, and so far things on this front are tracking along fine.
Jason L. Ware, MBA
Market Strategist, Chief Analyst
Albion Financial Group
(801) 487-3700; (877) 487-6200