The Looming June Stock Market Correction

The greenback hit a six-month low overnight against major currencies. The ICE Dollar Index, which measures the value of the USD against a basket of currencies, fell 0.8%, to 98.109. The dollar hasn’t seen these levels since Donald Trump won the presidential election in November.

Investors dumped the currency following his latest presidency storm. James Comey, former FBI director, was unexpectedly sacked last week. The shock move has unsettled markets. Punters think that Trump’s proposed economic policies will be delayed, especially tax reform. Instead of getting on with their jobs, the Democrats have called for an ‘independent investigation’ into the US election over alleged Russian interference.

Talk about a ‘dog and pony’ show. Confidence in the world’s largest economy has nosedived.

Amid the chaos, the euro has skyrocketed to the highest level since early November, surging 0.94% against the greenback. French President Emmanuel Macron’s win sparked ‘optimism’ across the Eurozone earlier this month. Traders anticipate that Macron will work with German Chancellor Angela Merkel on fixing problems plaguing the EU, which should provide ‘more of the same’ for Europe.

And while that should worsen Europe’s growing economic problems, the short-sighted market isn’t bothered. ‘Capital that has fled Europe last fall is finally [going] back there, supporting the euro. Political risk in Europe subsided while it is escalating in the U.S.,’ said Colin Cieszynski, senior market analyst at CMC Markets, to Market Watch.

Richard Perry, market analyst at Hantec Markets, said in an investment note that the greenback is ‘…coming under increasing corrective pressure amidst data disappointment and more concern over Trump.’

There’s plenty of political and economic uncertainty hitting the US. Housing, retail sales and inflation have all suffered in recent weeks. In my view, as discussed yesterday, the US Federal Reserve won’t raise rates next month. That could cause the first stock market correction in over 18 months.

I’ll explain…

The ‘experts’ view

Goldman Sachs chief economist Jan Hatzius wrote overnight in a note (my emphasis added):

Despite sharply weaker core inflation in the last two months, we continue to expect rate hikes in June and September followed by an announcement of balance sheet runoff in December, as well as a funds rate path well above the forwards in 2018 and beyond.”

‘[But]… “The risk to our near-term funds rate view is now slightly greater, largely because the range of plausible outcomes has widened. We have shaved our subjective odds of a June rate hike to 80%, from 90% earlier, and have also become a bit less confident in a September hike. If the outlook deteriorates significantly, the committee might simply delay any further tightening steps.”

Indeed, the investment bank is doing what investment banks do best — fence sitting. It lowered its odds that the US Fed will hike in June and September. Focusing on June, though, the probability of a rate lift was close to 100% last week. According to CME’s FedWatch Tool, that sits at 78.5% today…‘coincidentally’ in line with Goldman’s views.

My bet: Goldman’s odds are likely to crash in the weeks ahead. Citibank’s US macro surprise index has hit a one-year low:


Source: Citibank
[Click to enlarge]

Year-on-year core inflation (excluding food and energy prices) was worse than expected last month. The headline number fell from 2.22% in February to 1.89%. The US Fed wants to see a 2% number. And with inflation falling below that target, the Fed could backflip on raising rates next month. The University of Michigan 5–10 year inflation expectations have also hit an all-time low:


Source: University of Michigan
[Click to enlarge]

The market isn’t paying attention to the real economic data. With higher crude oil and healthcare costs (as we discussed yesterday), people don’t have much free money to spend. US retail sales underwhelmed last month. They missed consensus, growing at their slowest pace this year. Dick’s Sporting Goods Inc. [NYSE:DKS] feels the heat. It announced poor sales for the first quarter last night, sending its stock price down 12%.

There’s more to the story…

Across the pacific

China has gained more attention in recent weeks. Remember, the country’s liquidity issues triggered a global stock market correction January 2016. That spooked the US Fed, which didn’t raise rates until December of that year.

That story could be repeating…

The Chinese suspended their bond market yesterday.

What followed?

The biggest one-day cash injection in over four months. The Peoples Bank of China pumped US$25 billion into the country’s financial system.

Fox Business reported overnight:

China’s central bank made its biggest one-day cash injection into the country’s fragile financial markets in nearly four months Tuesday, a fresh sign that Beijing is trying to mitigate the damage to investor confidence inflicted by its recent campaign to tamp down speculation fuelled by excessive borrowing.

The huge provision of cash follows comments from Chinese officials in recent days that suggest they are concerned that recent moves to tighten market regulation have caused too much disruption.

President Xi Jinping’s call for financial stability ahead of a major leadership shuffle later this year led regulators to unleash a blitz of new rules. The banking regulator under new chief Guo Shuqing has cracked down on speculative investment practices that relied on borrowed money and has also imposed sharply higher fines for irregularities.

But the new regulations, alongside tighter monetary conditions in China, have proven hard for investors to absorb. China’s main stock market has dropped 5.4% in just over a month, while yields on Chinese government bonds have risen to more-than two-year highs. Bond yields rise as their prices fall.

China’s rocky debt markets could trigger another stock market correction. And, considering the US economic data isn’t great, the US Fed could easily backflip next month.

The market isn’t worried, though…at least not yet. The Chicago Board Options Exchange equity put/call ratio dropped to 0.55 last night. The 21-day moving average edged down to 0.64. In other words, the bulls slightly outnumber the bears. Of course, with the ratio declining and the market complacent, don’t expect it to stay that way. It could flip just as quickly to the upside, when the panic comes.

Watch out for the economic data in the weeks ahead. If it gets weaker and the US Dow Jones Industrials Index closes below 20,798 points on a daily basis, it could signal a correction. And if that doesn’t worry Janet Yellen — the biggest dove at the Fed — I don’t know what will.

The bottom line: Global stock markets haven’t experienced a 10–15% correction for 18 months. We’re overdue for another one (the Aussie stock market included). There’s plenty of uncertainty building across the globe, which could trigger another correction. If that happens, the Fed is likely to backflip on raising rates next month.

Regards,

Jason Stevenson,
Editor, Markets & Money

PS: My colleague Vern Gowdie believes the world is ‘high’ on money printing and low interest rates. In his view, we’re looking at more than just a stock market correction. Vern is calling for an imminent 70–80% stock market crash. He’s laid out the evidence in his new book, The End of Australia. And he explains the steps you can take today to protect yourself for the mother of all meltdowns. To find out more, go here.

Jason Stevenson

Jason Stevenson

Analyst at Markets & Money
Jason shares his extensive knowledge of Australia’s mining sector as Markets and Money’s dedicated resource analyst. Whether it’s iron ore, gold, copper or lithium, you can rely on Jason to give you in-depth analysis of the biggest and most important sector of our economy. Jason provides in-depth research to Resource Speculator, Australia’s premier resource investment advisory. If you’d like to know more about Jason’s financial world view and investing philosophy then we recommend you join him on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Markets and Money essays.

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