Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Nvidia Numero Uno in Count Down to President Donald Pump Election Victory - 5th Nov 24
Trump or Harris - Who Wins US Presidential Election 2024 Forecast Prediction - 5th Nov 24
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Big Profits in the Big Difference Between a Correction and a Stocks Bear Market

Stock-Markets / Stock Markets 2014 Oct 14, 2014 - 12:39 PM GMT

By: Money_Morning

Stock-Markets

Michael E. Lewitt writes: The current downdraft in stock prices has understandably sent the happy faces on CNBC running for cover as they try to figure out what went wrong.

After all, the U.S. economy is growing and the Federal Reserve has made it clear that interest rates won't be raised until the middle of next year. How could stocks have the temerity to sell off?


We need to think through whether or not this market slump is simply a correction, or a harbinger of the kind of sell-off that puts our hard won gains at risk...

The Signs of a Correction Were Always There

Signs that stocks were due for a correction were obvious to anyone paying attention.

At about 16x forward earnings, stocks are valued meaningfully above their long-term average of roughly 14x. The Shiller Cyclically Adjusted P/E Ratio, which measures earnings over ten years, is currently about 25.5 versus its mean of 16.6x.

Certain sectors like social media are trading at stratospheric multiples reminiscent of the Internet Bubble and are ripe for a sell-off. Stock prices are inflated by non-organic factors - years of zero interest rates, low effective tax rates, and enormous stock buybacks.

S&P 500 companies are on target to spend $914 billion, or 95% of their profits this year on buybacks and dividends according to a data compiled by Bloomberg and S&P Dow Jones Indexes.

Much of the money being returned to shareholders is being borrowed at low interest rates, but this is clearly unsustainable. Perhaps investors are starting to look ahead and realize that earnings are going to need something other than huge buybacks and low interest rates to sustain their elevated levels.

There have been technical signs pointing to a correction as well (a correction is a 10% reversal from a market peak). The performance of small cap versus large cap stocks is one sign that technicians have been worrying about.

The small cap Russell 2000 Index has now dropped more than 10% from its high in March while large cap indexes like the Dow Jones Industrial Average and the S&P 500 are less than 4% off their recent record highs. Small caps could dramatically outperform on a rally, should it arrive.

More important, however, is the fact that the Federal Reserve is ending QE this month. The last two times it ended QE, the S&P 500 fell by 7% and interest rates also dropped. Thus far, markets appear to be following the same script. The S&P 500 was only down 3.8% from its closing record of 2,011.36 on September 18 to 1,935.10 on October 7, so it would have further to fall to match those earlier episodes.

Over that same period, interest rates have declined from 2.63% to 2.35%. If markets hold true to previous form when the Fed exited QE, stocks could fall further and bond yields could drop even lower before markets reach a new equilibrium.

An Indicator of What's Really Happening
There are other factors at work this time that have to be factored into the analysis, primarily the strong rally in the U.S. dollar. The dollar has rallied against the euro from $1.37 to $1.25 since mid-July and from $102 to $110 against the Japanese Yen. These are huge moves that conventional thinking holds constitutes an effective tightening of monetary policy that could provide the Fed with an opportunity to further delay raising interest rates beyond 2015.

The Fed has downgraded its growth forecast based in part on the rise of the dollar. A stronger dollar also hurts the earnings of multinational corporations as well as energy companies (since oil is purchased, for the most part, in U.S. dollars), so a strong dollar could actually create another headwind for stocks. That remains to be seen.

The one undeniable fact that is confirmed by both economic and market data is that the global economy outside of the United States is faltering. Japan is back in recession, Europe is about to join it, Latin America is a basket case with Argentina and Venezuela in crisis and Brazil stumbling, and China is slowing and dragging down the emerging markets.

Only the U.S. is growing (and has grown at better than 3.5% in three of the past four quarters). But U.S. growth has come largely courtesy of zero interest rates that are expected to end within the next year, throwing the outlook for growth into question. The best explanation for the current market correction may be that investors are acknowledging that global growth prospects are dim. Certainly the rally in bonds would confirm that.

Keep This in Mind When Looking for Discounts

Despite these ominous signs, it must be remembered that a correction is not a bear market.

A bear market is almost always preceded by a recession which in turn is normally preceded by an aggressive tightening of monetary policy that pushes short-term interest rates higher than long-term interest rates (flattening and then inverting the yield curve).

Every bear market in stocks has been preceded by an inverted yield curve. The Treasury yield curve has flattened significantly in 2014 but has not yet inverted and remains relatively steep, suggesting that both a recession and a bear market remain highly unlikely.

But a correction can still do a lot of damage and investors should buy cautiously when they buy on the dips.

Source : http://moneymorning.com/2014/10/14/big-profits-in-the-big-difference-between-a-correction-and-a-bear-market/

Money Morning/The Money Map Report

©2014 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in