In recent months we have been warning that the first deep dive in stocks since Trump’s 2016 election would be in the 1st quarter 2018. Once Trump passed the tax cuts last December we opined that the trigger for this market decline would be wage inflation and fear of higher interest rates. The strong economy was already adding inflationary pressure to material prices and labor costs. Then huge corporate tax cuts in December escalated these pressures as evidenced by the surprising early announcements that hundreds of larger companies have already promised bonuses, pension contributions, and wage hikes. We suspect a temporary spike closer to 3.5% growth in hourly earnings is coming over the next few months. The labor cost infused inflation (CPI) report due on the 14th this month may be another reminder of higher interest rate worries.
While a strong economy and earnings growth are critical to any bull market in stocks, the key psychology of market behavior is to fool most investors most of the time. When stocks exploded higher after Trump’s victory in 2016 we had almost 15 months of rapid appreciation that left too many investors on the sidelines awaiting a 5 to 10% pullback. With so much pent-up demand, we expected that the only way to keep investors from finding an easy entry to catch this market required a decline of well over 10%. With more inflation coming there could be still lower prices this quarter.
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The Dow and S&P 500 indices have now fallen 13 and 12% on an intraday basis in just over 6 days, qualifying for a fairly common but exceptionally fast correction that will scare investors. Here is what ExecSpec stock market forecasts have been saying in recent months:
10-24-17: In 1995, stocks ran higher for 15 months without exceeding a 3% correction before scaring traders with a 3-week plunge of over 11% intraday. A similar replay of 1995 would keep the buying frenzy going until about January 2018 before a “real” correction begins. (Source)
11-14-17: Our current expectation remains that more serious corrections of 10% or more will hold off until the 1st quarter of 2018 (Source)
01-15-18: Whenever a 5% correction arrives, it means the market will likely dive deeper and longer to scare buyers back to the sidelines (Source)
01-23-18: We continue to view this period into mid-February as a higher risk time for earnings euphoria saturation. A several months pause into the spring looks likely. VXX and SDS are the basic hedging ETF vehicles to use (Source)
02-03-18: We expect a deeper dive into March (Source)
Corrections of over 10% are almost an annual event (chart below). The quick 22% decline in the summer of 2011 occurred in a market that was far less overbought than today. Market declines of 9 to 22% have transpired each year of this bull market until 2016.
The February market meltdown that began with wage inflation fears has been usurped by automated computer program stop loss selling that has spread around the globe. Ironically the stock market panic on concerns over rising interest rates has begun to push bond yields lower this week and the dollar higher. The VIX (VXX) volatility index should quickly climax this week. This flight to the safety of Treasury Bonds and the US dollar will soon calm this equity panic as traders speculate on the new Fed Chairman taking a pause on the planned rate hikes this year.
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After a record period of almost 15 months without either 5% or even a 3% correction, this market was due for a big break, regardless of business earnings growth rates. The current liquidation phase should bottom in the 1st half of 2018 as previously forecast and provide the slack to energize the next leg higher in this record-setting bull market in stocks.
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