Stock market correction, or the beginning of a bear market? – Index News
February 6, 2018 5:26 pm
Global stock markets have not fallen this aggressively in years. While the carnage may still have some room to run, it is important to distinguish that this appears to be merely a correction in an otherwise robust uptrend, and not the beginning of a bear market in stocks.
Many have argued that a major correction in global stocks was long overdue, following spectacular bull runs in almost every major equity index in recent years. Some have even argued that a pullback would be healthy, as previously “overvalued” or “expensive” stocks corrected to more reasonable levels, making the broader uptrend more sustainable from a longer-term perspective. Unlike typical market corrections though, the latest plunge lacked a clear trigger, leaving investors scratching their heads looking for the correct narrative.
It all started with the yields on US Treasuries moving higher. As yields rise, bonds become more attractive to hold as they begin to offer a higher and “safer” return, something that typically curbs demand for stocks as investors rebalance their bonds-to-equities exposure. Indeed, once the 10-year Treasury yield crossed above 2.70%, US equity indices (and most global indices) started to correct lower. Then came inflation and interest rate concerns. US average hourly earnings surprisingly accelerated in January, and since higher wages are widely considered to be a precursor to higher inflation, markets began to bet on faster Fed rate hikes in the future, pushing stocks even lower in the process.
That’s all fine, but what happens now? Is this merely a correction in the global equity uptrend, or the beginning of a bear market? On balance, this still looks like a correction, and a rather small one considering the astonishing gains that equity indices have posted in recent years. That does not mean that the carnage is over, though. The plunge may still have room to run, and as most traders know very well, one should not attempt to “catch a falling knife”. That said, a variety of factors suggest that the sell-off is unlikely to persist for very long.
As mentioned above, one of the catalysts for the stock correction was rising US yields. However, once stocks began to collapse and risk aversion took hold, safe haven flight saw investors rush back into the traditional safe asset, US Treasuries. The increased demand for Treasuries means that yields came back down. Lower yields, in turn, exert less downward pressure on equities, helping to halt or at least to slow the pace of the decline in stocks.
Perhaps more importantly, nothing major has changed fundamentally. Economic data are still very strong in all of the major regions, and while signs of higher inflation may have spooked investors in the US, the same can hardly be said for Europe or Japan. Moreover, it is not strange for stock markets to correct following such robust gains, as some investors also take some profits off the table.
In the grand scheme of things, the main question is: how much lower can equity markets go before willing buyers appear to halt the decline? With bond yields being broadly on the rise, and stocks falling, large sums of money appear to be flowing out of both the bond and the stock markets lately. Thus, investors may be sitting on big piles of cash, which will probably be looking to reenter equity markets at more favorable levels. In other words, several market participants may be looking to buy the dip; the question is at what level they will jump back in.
Global stock markets have not fallen this aggressively in years. While the carnage may still have some room to run, it is important to distinguish that this appears to be merely a correction in an otherwise robust uptrend, and not the beginning of a bear market in stocks.
Many have argued that a major correction in global stocks was long overdue, following spectacular bull runs in almost every major equity index in recent years. Some have even argued that a pullback would be healthy, as previously “overvalued” or “expensive” stocks corrected to more reasonable levels, making the broader uptrend more sustainable from a longer-term perspective. Unlike typical market corrections though, the latest plunge lacked a clear trigger, leaving investors scratching their heads looking for the correct narrative.
It all started with the yields on US Treasuries moving higher. As yields rise, bonds become more attractive to hold as they begin to offer a higher and “safer” return, something that typically curbs demand for stocks as investors rebalance their bonds-to-equities exposure. Indeed, once the 10-year Treasury yield crossed above 2.70%, US equity indices (and most global indices) started to correct lower. Then came inflation and interest rate concerns. US average hourly earnings surprisingly accelerated in January, and since higher wages are widely considered to be a precursor to higher inflation, markets began to bet on faster Fed rate hikes in the future, pushing stocks even lower in the process.
That’s all fine, but what happens now? Is this merely a correction in the global equity uptrend, or the beginning of a bear market? On balance, this still looks like a correction, and a rather small one considering the astonishing gains that equity indices have posted in recent years. That does not mean that the carnage is over, though. The plunge may still have room to run, and as most traders know very well, one should not attempt to “catch a falling knife”. That said, a variety of factors suggest that the sell-off is unlikely to persist for very long.
As mentioned above, one of the catalysts for the stock correction was rising US yields. However, once stocks began to collapse and risk aversion took hold, safe haven flight saw investors rush back into the traditional safe asset, US Treasuries. The increased demand for Treasuries means that yields came back down. Lower yields, in turn, exert less downward pressure on equities, helping to halt or at least to slow the pace of the decline in stocks.
Perhaps more importantly, nothing major has changed fundamentally. Economic data are still very strong in all of the major regions, and while signs of higher inflation may have spooked investors in the US, the same can hardly be said for Europe or Japan. Moreover, it is not strange for stock markets to correct following such robust gains, as some investors also take some profits off the table.
In the grand scheme of things, the main question is: how much lower can equity markets go before willing buyers appear to halt the decline? With bond yields being broadly on the rise, and stocks falling, large sums of money appear to be flowing out of both the bond and the stock markets lately. Thus, investors may be sitting on big piles of cash, which will probably be looking to reenter equity markets at more favorable levels. In other words, several market participants may be looking to buy the dip; the question is at what level they will jump back in.
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