Did the market just experience a mini-correction? Or is this the beginning of something bigger? Why are news headlines making a big issue of a 1% drop in U.S. equities? Shall investors buy on the dips, or better protect themselves from the downside?
These were the top questions I received since Tuesday’s more than 1% drop in U.S. equities, but unfortunately, there are no black or white answers in our gray world.
A 1% fall in equities isn’t frightening. In 2016 we experienced 21 days of more than 1% drop in S&P 500, and the index still managed to gain 5% from January 2016 until the presidential election on November 8. Most of the gains since November 9 until the beginning of March of 12.4% were attributed to Trump trade and improving economic conditions in the U.S. and globally.
However, the price action experienced in the last couple of days indicates that the first phase of Trump trade is over. U.S. equities are currently priced for perfection, and now we should be looking for justifications of the overstretched valuations.
Worrying signs
Equity analysts are revising their earnings growth downward, Donald Trump’s approval rating by the latest Gallup Poll sank to 37%, and FBI’s Director James Comey hurt the President’s credibility even further.
Other worrying signs are coming from different asset classes. For example, U.S. 10-year treasury bond yields declined by more than 20 basis points from Mid-March highs. If this drop in yields reminds me of anything, it reminds me of Neel Kashkari, the President of the Federal Reserve Bank of Minneapolis, who was the only dissenter to raise interest rates in Fed’s last meeting. He was worried that the economic data did not back up the belief that things had gotten significantly better, and markets seem to share his skepticism by flocking to the safety of bonds.
Energy markets are sharing a similar story as well. Although oil prices were mostly pressured due to increasing U.S. inventories; prices should rally when the dollar falls which did not happen.
So, we need a lot of good news to keep investors buying into the second longest bull market ever.
Repealing Obama Care
Today will be a major test to Trump trade. The U.S. Congress will vote on the bill to repeal Obamacare after some modification took place on Monday. If the bill passed, we might see some relief in equities. However, there’s a high chance that more than 21 Republicans will vote against the health care plan, leading to the first significant loss of Trump’s administration. Such a loss would be perceived as jeopardizing the President agenda, and could potentially lead to shaking investors’ confidence.
I’m not calling for a major correction as of yet, but for investors who want to remain invested largely in equities, I suggest it’s a good time to think about buying a protection to protect from a market downturn.
