Much ink hasbeen spilled over the recent market quiver. The burning question now is: will the fall snowball into a correction?
On one hand, the bears are desparately trying to talk down the market. The key charge they made is that the economy is still in shambles. The soaring deficit and rising unemployment - both in the US and UK - are signs of a deteriorating economy. Moreover, they contend that the market has run ahead of itself, thus opening the doors for a big retracement. The bulls, however, counter with the fact that the worst is over and that the global economy is on track to resume growth by first half next year. Coupled with extremely easy monetary policies everywhere, a sustained recovery in equity markets is therefore achievable.
Picking out the winner among the two camps is difficult. While we have deep sympathies with the bears, it is impossible to ignore the market, especially when it is recovering strongly. Selling into an uptrend is probably not a good idea. However, there are a few risk factors that are worth monitoring. Huge moves in these series could impact equities:
(1) Energy. A sharp rise in crude prices above the current level (around $80), would certainly be bearish for equities (see right).
(2) Bond yields. Still steady, which is good for equities as investors are not overly worried about government finances. Sharply rising government bond yields, however, is not a good sign for equities.
(3) Dollar. The sweet spot for equities, judging from the recent movements, is gently falling US Dollar. A rout in the greenback is bad because it means investors are losing faith in the world’s biggest economy. A rise in the Dollar is also not good for equities since it signals expanding risk aversion. That is, investors are selling risk assets and moving into safe haven.
Overall, these factors are sustaining the bulls’ argument more than the bears, though crude oil’s persistent advance could damage the bull run and trigger a fall in equities, as it did in summer 2008. We will monitor these series actively and assess their medium-term trends.
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