The Crash Continues

A couple of weeks ago we wrote in The Crash of 2018 that more downside should be expected in stock prices.  We got it.  Yesterday stocks were down over 3%; around 9% this month.  On the grounds of valuation, rates, and the Synthetic Systems outlook, I still expect more downside.  But not necessarily imminently … frequently once a selloff is big enough to start making the front pages and the crowd reacts by selling, the market rewards it with a rally.

Of course stocks aren’t the only market.  Treasuries and gold rallied sharply as stocks sold off, their diversification benefit kicking in just when it’s needed most. 

So where have these much ballyhooed record corporate stock buybacks, the main support for US stocks this year, gone?  For the moment, many companies are in the “blackout” period prior to releasing earnings reports during which they’re not permitted to buy on the grounds of insider trading conflicts.  More generally we know that factors that made the market go up yesterday don’t guarantee it will go up tomorrow, and buybacks, in contrast to regular dividends, are much more ephemeral and mostly just boost prices while they’re being implemented. Companies are reluctant to pay dividends they don’t believe they can sustain, but readily buy back stock when they have a what they view as a less sustained surfeit of cash – and execs want to cash in some stock options.

Is there still more ahead? Systems doesn’t drill down to daily detail, but doesn’t suggest the current move continues a whole lot further.  Conversely, while a bounce wouldn’t be out of place here it doesn’t see a rebound back to new highs in the works for a while either. It does view this as part of an ongoing bear market in stocks that it’s been forecasting for a couple of years, consisting of a series of squalls like this (see Market Analysis) .  A bear market would make sense on a number of levels, particularly with still very high valuations for US stocks. Valuations have been a weight on equity prices for quite a while, merely overwhelmed by other factors such as ultralow interest rates and upward momentum. As the influence of these other factors wanes, valuation faces less competition and becomes the main driver of the market.  The only reason the market needs to go down is that it got too high in the first place.

The Powell Put is widely believed to exist at a much lower level than the Greenspan, Bernanke or Yellen puts. So markets aren’t generally looking for the Fed to come to the rescue. Part of its motivation in raising policy rates is the risk to financial stability posed by high asset prices. So lower asset prices would signify success, not failure, and I wouldn’t expect the Fed to short circuit its own success.  But beyond some point that fades too; as Powell himself has suggested, if markets pull back enough to pose a threat to broader economic stability, the balance of risks shifts. This is another reason to believe this particular October plunge has a limited downside; if it goes too far one of its main sources of nourishment can go away.

But even rate cuts wouldn’t quickly arrest the broader bear market. Nor would steepening of the yield curve. Despite all the notoriety the flattening yield curve has had concerning its ability to forecast “recessions” and by extension bear markets in stocks, those processes tend to occur not while the yield curve is flat or negative, but after it has begun to steepen again. In the bear market of 2000-2003, short term rates began to fall at the end of 2000. The 10-1 year treasury spread went positive at the beginning of 2001. In the bear market of 2007-2009, rates began to fall in 2007. In both instances the bulk of stock price declines occurred after rates began declining. This cycle is unlikely to be an exception.

Market pundits in the mainstream financial media are now talking about a “correction”. Many have redefined “bear market” as something the market “enters” when it’s 20%+ down.  We cynics may suspect Wall Street wants to avoid using words like “bear market” as long as it can to avoid scaring its mainstream audience out of their stocks until it’s had a chance to sell more of their own. Not being fans of dumping assets after they’ve already gone down a lot, we don’t use those revisionist definitions on this site. I have to laugh … while the mainstream’s terminological artifices have them tied up in knots trying to figure out whether this is going to lead to a bear market, we don’t have to worry about that.  We say stocks have been in a bear market since prices topped on January 26. All that remains to be seen is how much further it goes.