Dolan: The Market Slide Is At Extreme Levels

Market Slide Reaches Extreme Levels

The first three weeks of 2016 have already made market history: the largest decline on record to start a new year. Investors have been shaken and the doomsayers are getting their moment in the spotlight. In last week’s article, I argued that investors should not panic and instead stay focused on the big picture. And that big picture has not changed significantly in the last three weeks.

Recent market declines have become excessive on technical momentum studies (see the Relative Strength Index (RSI) in the S&P 500 Index below) and I believe there is more than a fair amount of overshoot at the moment. That’s why the financial chattering class has started talking about markets becoming disconnected from the real economy, which was my point last week.

While it is too soon to call a bottom, there are some early signs of a potential near-term bounce delivered just in the last two days. My expectations of +/- 5-10% moves in developed markets has been met and slightly exceeded in some cases, while my Emerging Market range of +/- 10-15 % is still intact. Oil prices have effectively hit my targets and bounced (“…we do not exclude weakness to $25/barrel for US WTI/$28/barrel for Brent crude”). Importantly, these early signs of bottoming are being reinforced by real-world developments, which is the only way to cut through the fog of a market panic.

Economic Policymakers Begin To Respond

In terms of the larger view I laid out in the 2016 Global Market Outlook, I suggested that economic policy support would be delivered during the course of the year in many of the major global economies. Market events have accelerated the timetable for those actions far ahead of my expectations, but the key is that they are in the process of happening.

In particular, I suggested that the European Central Bank (ECB) and the Bank of Japan (BOJ) would be compelled to undertake additional monetary stimulus. At today’s press conference, ECB president Mario Draghi strongly signaled that the ECB would consider increasing the size of its asset purchase program at its March meeting. The BOJ chief, Kuroda, has taken a wait-and-see attitude for the time being, but it’s clearly on the table for consideration.

I also went against consensus in suggesting that the US Federal Reserve would move far more slowly than markets or the Fed itself were suggesting, and deliver “only one additional rate hike, if that….” The sharp declines in global and US markets have seen markets slash Fed rate hike expectations for 2016, with some now suggesting that the Fed will have to backtrack and possibly even cut.

In China, I relied on the central government to stay active in supporting the broad economy and in taking action to stabilize domestic stock markets. From the World Economic Forum (WEF) taking place in Davos this week, we just received assurances from China’s vice president that China would remain an engine for global growth, and that officials would ‘look after’ individual stock investors (but not predatory speculators). He also declared that China has no intention to devalue the yuan.

Emerging markets excluding China remain the major trouble spot and so far have shown no signs of bottoming. However, the rout in oil appears to have run its course, while the broad CRB commodity index has achieved parity with an earlier wave lower in 2015 (shown below), suggesting additional bottoming potential. Stabilization in oil and other commodities would go a long way toward calming rattled markets and allowing for a more meaningful rebound. Keep an eye on those recent oil/commodity lows. If they should fail, then it may start to get really ugly (not my expectation).

Keep Your Eyes On The Ball

The global growth outlook has been shaken, but not de-railed by recent market dislocations. My outlook remains for stable, if lackluster, global growth against a backdrop of exceptionally low interest rates. The key players in the major economies have received an unwelcome wake-up call from markets and have responded with signs of pro-active flexibility. Such efforts are likely to contain further downside and I would look for a short-term correction at a minimum.

In the bigger picture, I’m sticking with my view that major global markets are likely to see-saw throughout the year, suggesting a more pro-active tactical investing approach (buying dips/selling rallies). There are enough risks to the global outlook to send prices down (as we have just seen), and also to limit any significant upside. Official policy moves are likely to act as a stabilizer, preventing worst-case outcomes (limiting downside), but not offering enough juice to spark a sustained trend higher (limiting upside). The first move has clearly been south. Time to start planning for what to do when markets recover their balance and investors realize the global outlook is not so bad.