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US indices give back early gains

By David Morrison  |  22/11/2018 09:12

Wednesday initially brought some respite for stock market bulls in a shortened US session. But the Dow erased a 200-point gain ahead of US Thanksgiving

We saw an early bounce across global equity indices on Wednesday. Perhaps that should be no surprise given the pace and degree of this week’s sell-off. Having said that, indicators such as the Relative Strength Index (RSI) and Moving Average Convergence-Divergence (MACD) don’t suggest that the S&P 500 is particularly oversold, certainly when compared to how the two indicators looked in October. However, a short-covering bounce is perfectly reasonable given the sharpness of the equity market’s decline, particularly as US markets closed early in the last session before Thanksgiving and ‘Black Friday’. Trading volumes were light, so it didn’t take much to move the major indices. However, what should concern stock market bulls was the late sell-off in the Dow which completely erased a 200-point gain.

Concerns with tech

The S&P 500 has now lost around 10% since the beginning of October when it was trading near its all-time high. A 10% fall is not that dramatic, but it is relatively unusual. Apart from the sell-off earlier this year, investors have rarely experienced such negative moves since Trump’s election win in November 2016. But what has really dented confidence has been the 20%-plus slump since early October in market-leading tech stocks such as Apple and Amazon. Even Alphabet, Google’s parent company, briefly dipped into bear-market territory in Tuesday’s trading session. Then add in Netflix and Twitter which are both down 36% since hitting their respective highs back in June this year, and Facebook which has fallen 39% since July. Yet the tech-heavy NASDAQ 100 is ‘only’ 14% below its record high and back to levels last seen this May – hardly a reason for investors to panic.

No panic – so far

Additionally, other traditional ‘safe-haven’ assets such as gold, US Treasuries and the Volatility Index (VIX) are hardly suggesting that investors are stressing out and preparing for a market meltdown. All have risen recently, but so far there’s no evidence of genuine fear in the markets. Now, this could be interpreted as a positive sign, proving that investors are taking the current repricing of equities in their stride. The counter-argument is that this apparent lack of concern indicates that we haven’t seen the worst of things yet and that there’s more pain to come.

Sell the rallies?

Nevertheless, there is chatter that it’s now time to sell rallies rather than buy dips – the latter being a strategy that has proved immensely profitable over the past few years. So what could lift market sentiment and persuade investors that the correction in equities is over? A major positive would be if there were to be a breakthrough on the ongoing US/China trade dispute. There are hopes that Presidents Trump and Xi Jinping will meet to settle their differences at the G20 meeting in Argentina at the end of this month. But the recent rhetoric coming from the US has been contradictory to say the least. On Tuesday White House Trade Representative Robert Lightizer accused China of continuing to engage in Intellectual Property theft. This followed on from US Vice President Mike Pence’s comments at last weekend’s Asia-Pacific Economic Cooperation (APEC) summit. Mr Pence said there had been major differences between the US and China, not just on trade, tariffs, forced technology transfers and intellectual property theft, but also extending to human rights and freedom to navigate the seas. At the same time, Trump’s chief economic advisor Larry Kudlow and Treasury Secretary Steven Mnuchin have been busy talking up the prospect of a deal. This suggests that we’ll have to wait until G20 to get clarity.

What about the Fed?

There’s also the issue of the Fed’s stance on further monetary tightening. The last few weeks have seen a softening of the US central bank’s hawkish rhetoric over rate rises and quantitative tightening. On the face of it, this should be market-positive. But the optics behind a pause in future rate rises are awful. For a start, this would represent a reversal of the Fed’s oft-stated confidence in ongoing US economic strength. Even if their trick is to blame the rest of the world for an economic slowdown, this would still feed into a poorer outlook for the US. Secondly, backing away from the Fed’s projection of four 25-basis-points-worth of rate hikes between now and the end of next year would look political, given Trump’s recent criticism of the Fed under Chairman Jerome Powell. Is the Fed really going to reverse-ferret and risk spooking the market over a weaker global growth outlook when most of Wall Street is, publicly at least, urging investors to keep fully invested?

A bullish perspective

On the flip side, stock market bulls have seasonality on their side. Not only do US equities tend to rally over Thanksgiving week, but the nine months following US mid-term elections (October through to June) are generally strongly positive for US equities. But at the risk of espousing the most dangerous phrase in trading, maybe it’s different this time? Some investors are concerned that we’ve already seen ‘peak earnings’ in this cycle. The trouble is, we’ll have to wait until the release of fourth quarter corporate results in the New Year for confirmation. In the meantime, the question remains: is the current sell-off simply a healthy market correction, or a precursor of worse to come?
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