On Tuesday, January 19th, US stocks reached the highest level since September 30th, 2008, a sixteen month high. For the rest of the week, stocks declined 5.1%, reminding investors of the dark winter of 2008-9, when stocks seemed prepared to drop to zero.
We remain relatively sanguine for several reasons:
1. As annoying as it is to see stocks fall 5%, the current decline rolls stock prices back to December 8th. Compare that to the bear market bottom of March 2009, when stocks hit a 13 year low!
2. US stocks gained over 70% from the March 9, 2009 low. Aside from a 7.1% pullback in June-July 2009, stocks were pretty much straight up for 10 months. A garden variety 5-10% correction is not out of bounds.
3. The solid rally of the previous seven weeks was driven by expectations of solid January earnings ("buy the rumor.") Now that we actually see the earnings reports (and they're pretty good) investors are "selling the fact!"
4. Against all year-end forecasts, the US dollar is surging. This drives down commodity prices (commodities are generally paid for in dollars, but produced in local currencies such as the Saudi Riyal, Australian Dollar or the South African Rand.) A stronger dollar means that non-dollar countries must pay more for industrial inputs, which chokes off the resurgent world economy.
5. The Chinese stock market in particular, but emerging markets in general, are down on the year as investors take profits after last year's triple digit gains.
6. Many of whom we call the "smarty-pants" investors (hedge funds, day traders) aggressively shorted the market over the last few months and were getting killed. To recoup, these traders need to slam the market to spook other investors. It doesn't surprise us that 50% of today's decline occurred between 3-4PM. As we saw last winter, the traders load up all their shorts for 3PM, particularly shorting the ETF's that have the power to move markets. All those sales hitting simultaneously cause the broader market to over-react and dump stocks. It's market manipulation, pure & simple, but the SEC has neither the expertise nor the will to police the rules.
What would it take to drive sharper market declines beyond what we already saw this week?
1. Earnings coming in worse than expected - so far not an issue
2. Leveraged investors facing margin calls - so far not an issue as leverage ratios are down sharply compared to a year ago.
3. Economic news that implied a "double-dip" recession. So far the world's economy is recovering at a moderate pace, with Europe and the US bringing up the rear. We see "slow growth" but not "no growth" or "negative growth."