In Selling The Drama Or Buying The Rally (8/27), I delineated the way in which 10%-plus price corrections had unfolded under similar circumstances in history (e.g., 1998, 2010, 2011, etc.). Specifically, when the prospects for the global economy are deteriorating, U.S. stock benchmarks typically reclaim about one-half of their losses on “hope rallies.” Afterwards, they retest their lows.
The most recent example of the price movement phenomenon is the euro-zone crisis. In late July/early August of 2011, the S&P 500 SPDR Trust ETF (NYSEARCA:SPY) plunged 16% due to fears surrounding economic malaise and financial credit concerns in Portugal, Italy, Greece and Spain. The popular ETF then recovered one-half (nearly 8%) of its price decline in late August/September before revisiting new lows in early October. At that point, the European Central Bank (ECB) and the Federal Reserve dropped market-moving hints about extraordinary stimulus measures, effectively ending the panicky price depreciation.
In the same vein, the present corrective phase for SPY stopped short at roughly 12%. The popular ETF then retraced about one-half of the price erosion (6%) on two recent occasions. And now, in spite of the Federal Reserve’s decision to refrain from a borrowing cost hike (probably for 2015 in its entirety), SPY’s price movement strongly suggests that the ultra-accommodating policy of zero percent interest rates may be inadequate; that is, we’re likely heading back to the recent low point of the current year.
Shouldn’t the Fed’s September decision to hold off any increases in borrowing costs have catapulted the U.S. stock market higher? Shouldn’t we have seen speculative buying demand for riskier assets like high yield bonds and growth stocks? Not when the U.S. has been contending with a sharp slowdown in exports, manufacturing activity as well as consumer sentiment. Not when the Atlanta Fed forecasts anemic GDP of 1.5% for the 3rd quarter. And not when chairwoman Janet Yellen acknowledges the absence of wage inflation as well as the the presence of labor troubles via the labor participation rate.
Prior to the rapid-fire declines for the Dow, S&P 500 and NASDAQ in mid-August, I detailed these economic concerns in extraordinary detail. I highlighted the dreadful manufacturing data in the Philly Fed Survey as well the Empire State Manufacturing Survey in 15 Warning Signs Of A Market Top. On, July 30th, I pointed to economic weakness in both the U.S. and across every region of the globe as being one of 5 reasons to lower one’s allocation to riskier assets.