Andrew Sheets, chief cross-asset strategist at Morgan Stanley, recently said that the recent correction was just an “appetizer, not the main course.” Chris Watling, chief executive of financial advisory firm Longview Economics, also said that market models show a “third wave” of the market correction is coming. This comment was released at the time when US market was taking a break from its rebound after the February market correction. It might have frightened off bottom fishing vendors. Thereby the recovery was slow and modest.
I would seem to agree on Andrew Sheets’ description of an appetizer, but I am not so sure when is the time he suggests for the “main course” to be served. I personally think the time break in between will be longer than immediate, or longer than the third wave description.
The wave theory suggested by Watling was that the current rebound is the second wave (see line A on Chart A), the third wave will be seen as another downturn to make lower low of the bearish trend (possible Line B in the same chart).
However, there are at least 5 reasons to think the recent sell off was just a temporary event. It is indeed like an appetizer to prepare dinner guests to grudge for more food.
1. Investors were still Cautious
Basically investors at broad are still very cautious and hesitate to enter market. The fear of the decadal curse was still hanging around 2018. They were too much frightened by the 2008 market crash that they have vowed never to return to market ever again. This down turn has confirmed their fear. But if the market recovers back up running smoothly again, the mood would change, fear will be gone as they heard everyone is profiting from the market.
For the next turn, they would believe market is just taking a “healthy correction” again just like the February correction. Then more investors would dare to do bottom fishing. For this round, no one dares to suggest buying at the dip. Even most market analysts were muted at the first week of the drop. Because everyone was frightened by its sudden down turn and thinking on the decadal curse’s imminent. Just like what Warren Buffet said, when everyone is fearful, be greedy. This moment could be the best possible time to be greedy, buy at the dip.
2. Market not at Euphoria Yet
Bull markets do not die on old age but on Euphoria. The late legendary investor Sir John Templeton put it beautifully, “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” Jim Cramer, the host of “Mad Money” said we are not there in euphoria yet. We are still in optimism stage. Jim Cramer does advice investors to watch for euphoric clues in 2018. Currently investors are basically just optimistic about US and the World economy, US employment future, Corporate Tax cut effect, and others. They have just begun entering the market like a new flock.
3. Corporate Tax Cut not Effective Yet
Trump administration has just ironed out corporate tax cut. The reality has not been really placed on the road yet. When tax cut has really been on place and running, the US economy will be effectively pushed up, more jobs and spending will be rolling on. The US and global economy will have changed drastically. At that time, investors will think bear will never come. By then, all of us should be vigilant and withdraw from the market slowly.
4. Rate Hike Not High Enough Yet
Recent pull back has to do with the fear of rate hike. But the reality check is that, though rate hike is something to concern and bond yield rise might have caused investor to switch appetite for investment instrument. However, its hike is not yet up until it can cause market crumble down yet.
Chart A shows all historical rate hike ceiling and each corresponding market crash in the past 30 years. When a technical line is drawn between all these ceilings in the past, except for 1980, its reasonable hike ceiling would be probably around 1.75 -2.00% or more for 2018. It certainly should not be sensibly increased up to 4-6% anymore as what other institutions’ projection has suggested. This would be more of wishes of hope than reality. Current rate is merely on 1.50%. There are still some more head rooms for Fed interest rate hike to go up further.
5. Not Enough Blood on the Streets
Over the market crash 2 weeks ago, though there were wounds and brutality on the streets, but the true brutish nature of the market has not really shown out. The first drop was only 65.75 points in S&P Mini Index Futures, the second which was the worst drop was 149 points. This is comparatively like a correction which has happened few years ago. If there were to be a bear market initiative, the drop would likely be larger than these.
For this time, there was just not enough selling pressure to pull the market down to continue the bearish journey. It showed that the bear was killed just started down without resuscitation. Due to the reason that market has not drawn enough frenzy maniacs into the playing field yet.
This event was just an appetizer for the purpose of conditioning investors for the drawdown, particularly so for the novice investors. For the next turn, many investors would have the boldness to go for bottom fishing, and then the danger is probably arriving without anyone noticing it. There will be more blood on the streets by then.
For this round, I would probably expect market such as S & P 500 Index Futures would develop a healthy slow and steady uptrend instead (as shown in Line C on Chart A). For this round, it would probably still be safe to do bottom fishing with 100% jump into the fish pawn. But for next round, we better watch out before we leap.
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