Dow Jones close to a correction
Since April, the prominent finance professor has used a baseball analogy in CNBC interviews to characterize where he believes the market rally stands. On April 8, he said Wall Street was in the “third inning of the boom,” but on May 7, he said it was more like the sixth.
“I believe we’re in the eighth inning before a pitching change. It’s difficult to talk about the market’s short run. “I don’t think the bull market is over,” Siegel said on “Halftime Report” on Tuesday. “We’re getting close to the point where we’ll have to get some of the slop out, reset, and look forward.”
Stocks have struggled thus far in September, which has historically been a difficult month for the market. So far this year, the S&P 500 has experienced a 4 percent decline, which is unusual and has led some market strategists and commentators, such as Siegel, to believe a larger drawdown is likely.
A market correction is typically defined as a 10% or greater drop from the most recent high.
Siegel stated that he is looking for, but is having difficulty locating, a major, bullish catalyst that will allow the market to “surge ahead” this fall.
“I do think if Covid peaks and we get that data — and I do think the Fed is going to tee up the taper so that rates rise toward the end of the year — we will see a rotation,” Siegel said, referring to the US central bank beginning the process of reducing its monthly asset purchases and bond yields rising in response.
The Fed is expected to begin tapering later this fall. In response, Siegel predicted that “tech is going to take a breather, and those cyclical and small-cap stocks that have been hammered may come back as a result.”
Siegel has been arguing for months that inflation in the United States will be hotter and more persistent than Fed Chairman Jerome Powell and other central bankers have publicly stated. As a result, he is concerned that the Fed will need to slam the brakes and ease its highly accommodative monetary policy in a more dramatic manner than most expect.
However, the Labor Department reported earlier Tuesday that consumer prices rose at a slower-than-expected rate in August. While Siegel believes the consumer price index understates the extent of price pressures, he believes the report supports the Fed’s belief that higher-than-normal inflation will be transitory.
As a result, Siegel believes the hypothetical “day of reckoning” — in which the Fed dramatically tightens policy in response to new, problematic inflation data, causing problems for stocks — has been “definitely postponed.”
“What we see is that the Fed does not need to panic,” he continues.
Yesterday’s small bounce alleviated some short-term oversold conditions while appearing to be about traders anticipating another successful test of the S&P’s 50-day average, taking comfort in solid Covid/spending trends, and getting ahead of a monthly pattern of expiration-week comebacks.
What’s the big deal about expiration weeks, which have seen weakness bottom near the 18th/19th of each month in the past few months? A condensed version: Clusters of open options positions near specific index levels are the mechanical forces exerting some sway on the market. They are currently near 4,500 on the S&P 500 ($450 on the SPY ETF). As investors purchase options, dealers hedge by purchasing stocks, which provides support if those exposures remain mostly above current prices. As the expiration date approaches, the exposure decreases, as does the need for hedging-related purchases.
Large macroeconomic and corporate news, large swings in bond yields, or Fed messaging can all overcome these derivatives-related flow effects. However, we have recently had a consistent if softening macro environment, a predictable Fed, and companies universally exceeding profit forecasts, albeit predictably.
For the time being, the market has not demonstrated that its character has shifted from the rotation-aided upward grind with internal corrections that has been in place all year. However, keep an eye out for signs of a break with this mode. The S&P 500’s 50-day average (4,433, down less than 1% and just below Tuesday’s low) and August’s low near 4,370 would be the next downside targets.
There is plenty of evidence of market mid-cycle dynamics at work. GDP is slowing, but demand is being postponed rather than destroyed. The Fed and other central banks are planning to reduce stimulus, but only from a super-easy starting point. Inflation is widespread, but it is related to growth-restraining shortages and bottlenecks rather than overheating growth.
All of this has been processed fairly orderly by the market. Here are three cyclical market segments – consumer discretionary, industrials, and banks – that have held most of their YTD gains but have been idling sideways for months as we await the pace of reopening/reacceleration. Treasury yields are moving in the same direction. Today’s decent retail sales data warns against being too pessimistic about underlying consumer trends.
The most pessimistic interpretation of all of this would refer to the 2010-2011 period: Fragile recovery, central banks already all-in and some pulling back, surging energy prices, pushback on further fiscal spending increases, and debt-ceiling shenanigans in Congress causing unnecessary angst Nonetheless, the differences favor the present: We have no bank or sovereign solvency issues; consumer balance sheets are healthy; the baseline economic growth rate and fiscal thrust are much higher; and the Fed has now pledged not to tighten ahead of time.
The investor mood has undoubtedly become more defensive, with many strategists predicting a deeper pullback and the (admittedly volatile) AAII retail investor survey leaning heavily toward the bearish camp.
Individual Investors Association of America
Nonetheless, the evidence of investor action has leaned toward optimism, as they have poured new money into stocks. Net flows into the large SPY ETF increased dramatically as September approached. Suggests that the public has gone “all in,” with no need to chase the market higher.
The credit market is still strong. Treasury yields are holding up well (neither panicked over inflation nor clenched-up about a deep slowdown).
Market breadth is not bad at all, with a 40/60 up/down split. Small-cap stocks are outperforming. It was more of a noisy session than a bad one.
VIX is hovering in the 18s, reacting to the chop but not necessarily bracing for it to worsen quickly.