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Stocks just crashed and buying the dip looks tough


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Perhaps fortunately, a flight to safety is pushing bond yields lower this morning- countering the worry about rising rates. If investors are calmly look at the fundamentals, falling rates today should ease the sell-off. But. More often than not, massive one day drops mean fundamentals go out the window and traders dive for cover.

Strength of the rebound in doubt

The rebound is US equities since the February crash have a few question marks. The rising price of the S&P 500 index has been accompanied by falling volumes- typically a sign of waning enthusiasm from buyers. On the Russell 2000, the stocks most shorted in the February crash have significantly outperformed on the rebound. So short-covering was a significant factor. According to fund flow data, funds from US retail investors (excluding dividend reinvestments) have dried up completely since February. In the past few months, a sign of defensive investing has shown up in the outperformance of high dividend-yielding sectors like healthcare.

Reasons a crash could be on the cards

We are probably all familiar with the risk-factors for todays market. The trade war, the Italian budget, rising protectionism, a growth slowdown in China, anxiety over US mid-term elections even Brexit. These are all valid concerns that have shown up in world markets. Emerging markets entered a bear market months ago and European shares have not made new record highs this year. In the US, the impact of these global concerns has been masked by Trumps tax cuts. Tax cuts coupled with a higher available return on cash has seen capital return to the country while US companies have initiated plans for a record-breaking $1bn in share buybacks. Markets are looking 12 months ahead to when the positive impact of Trumps fiscal stimulus fades and voting with their feet.

The real issue: a liquidity crunch

The central concern- that has building and is now rising to the surface is the issue of a shortage of US dollars- and its impact on the price of the dollar and US interest rates. Overseas investors have found it harder and costlier to get hold of US dollars this year thanks to quantitative tightening and the large new issuance of treasury bills. This is an issue when global debt is higher- and dollars represent a higher proportion of that debt- than in 2007. When debt is high, and the cost of borrowing reaches a certain level, the natural result is a rise in defaults and a more difficult time for the global economy. The IMFs global growth warning this week has clearly hit a few nerves.

Why a crash can still be avoided

The reason many have looked over rising yields and a stronger dollar as an issue is because the US economy looks very strong. The idea of the US sneezing and the rest of the world catching a cold isnt a worry when the American economy has such rosy cheeks. And with earnings running near 20% y/y, corporations look even healthier. A few well-received earnings reports could do a lot to ease fears.

The current dip in confidence can be allayed were the Federal Reserve to signal it is easing off its quantitative tightening and rates rises. But the Powell Fed has shown more confidence in the face of market uncertainty and we dont expect any change in tone. We expect the Fed will hold on for the ride. The aim being to signal strength of its policy convictions. The silence from the Fed to this market weakness will be deafening.

Dow Jones and US yields at important juncture

The biggest worry for any fund manager is the inability to diversify- ie when stocks and bonds move down in unison. This what is staring them in the face right now. Right now there is a potential shorter term double top in the Dow at the same time as a breakout of a longer term double bottom in 10yr treasury yields.

The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest and nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please note that79% of our retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing money.



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About the author


Jasper joined the market analyst team in the London office in 2016, and has accumulated over ten years experience working in the financial markets.
 
He delivers regular commentary, seminars and webinars on market news, trading analysis, strategyand psychology. He is regularly interviewed by BBC News, Bloomberg, CNBC and Sky News, and has featured in The Times, Guardian and Daily Telegraph.

 
Before joining LCG, Jasper worked as a market analyst and as a market strategist at two other well-known broker-dealers in the City of London and on Wall Street.
 
He writes a widely-followed daily market wrap, plus commentaries on US, European and UK stock markets, FX and commodities. Jasper also hosts a weekly charting analysis webinar.
 
Jasper uses both technical and fundamental analysis. Fundamental analysis includes taking apart company earnings reports as well as reviewing economic data and the moves from central banks.
 
From a technical perspective he uses a systematic, trend following approach to trading. This typically involves a blend of price-action orientated trend and pattern analysis with the relative strength index (RSI) technical indicator to confirm changes in momentum.
 
He is qualified as a Chartered Market Technician (CMT) with the Market Technician Association, and has a degree in Finance and Economics.

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