A market priced for perfection will start to wilt when investors realize things aren't particularly perfect.» Read More
Investors have been agonizing over how big a threat China poses to the global economy, but they may be looking in the wrong place.
China's stock market has tumbled following stratospheric gains that peaked in June, while economic data indicate that the nation is likely to fall short of its 7 percent growth expectation.
What matters more than either metric, though, is China's plan for retooling its economy, from one focused on industrial and housing growth atop piles of debt to consumer-based gains in consumption and investments in the stock market.
How they go about achieving that strategy, in part by reducing the amount of foreign debt purchases, is what could have more impact than anything else.
"There is a strong case to be made that it is neither the selloff in Chinese stocks nor weakness in the currency that matters the most," George Saravelos, forex strategist at Deutsche Bank, said in a note to clients. "Instead, it is what is happening to China's FX reserves and what this means for global liquidity."
In 2003, China began a "reserve accumulation" program that amounted to the equivalent of $4 trillion, which exceeds even the $3.7 trillion or so in a similar quantitative easing program the Federal Reserve initiated in 2008 and ended in October 2014.
During China's massive QE run, it increased its U.S. Treasury holdings by a factor of 10—from $120.7 billion in 2003 to $1.27 trillion in June 2015, according to the latest U.S. Treasury data. All that buying pushed it past Japan in the global lead for holders of American debt, while keeping U.S. yields low and producing, except for the financial crisis, a flat yield curve.
There have been so many factors influencing the market's twists and turns now that it's easy to lose count.
Let's, however, take a look at seven that seem to be the most prevalent influences of the rapid-fire price action lately.
1. Price discovery
The notion that the marketplace actually can find a rational price, absent the influence of meddling central bankers, seems almost quaint. But we could be in the beginning stages of true price discovery as the Federal Reserve keeps the monetary printing presses shut down and prepares, at some point, to normalize interest rates.
Following the market correction that put the S&P 500 12.5 percent off its 52-week high, the index's price-earnings ratio has fallen into line with historical norms near 16. In short, the market may finally have come to grips with the notion that in an economy struggling to grow more than 2 percent, a multiple of 18 is a little expensive.
Couple that with a market that hasn't corrected in nearly four years, and you've got some key ingredients for volatility.
"What I think we're seeing is a typical late-stage bull market in which there are precious few shock absorbers for the market to withstand even a modest negative impact," said Scott Clemons, chief investment strategist at Brown Brothers Harriman. "When something happens, the market reaction is going to be magnified."
2. The Fed
Fed actions seem like low-hanging fruit at this point, but the logic is hard to dispute.
The S&P 500 had gained more than 7 percent from Jan. 1, 2014, until Oct. 29, which was the day the U.S. central bank ended the third round of quantitative easing, a monthly bond-buying program that swelled the Fed's balance sheet to $4.5 trillion and jacked up the stock market index by nearly 200 percent.
Since the end of QE3? The market's down about 4 percent. Pretty simple, maybe too simple, but hard to ignore.
China's economy is in flux, and central planners are desperately trying to use policy to soothe market fears that the nation is heading into a deep and prolonged slowdown.
In keeping with point No. 1 here, China spooked a fragile market that might, at less lofty valuations, have been able to withstand a growth shock to the world's second-largest economy.
"Recent developments in China simply catalyzed a much-needed and overdue valuation correction in the U.S. stock market," S&P Capital IQ analysts Michael G. Thompson and Robert A. Kaiser said in a note. "To be sure, investors need to be concerned with market liquidity issues, anticipated corporate earnings growth and China's economy, but the market correction witnessed this past week was a necessary valuation correction that simply needed a catalyst."
What China leads to on a longer-term basis is hard to gauge, though some perspective is probably in order.
"The real broader view here is this is a natural correction in a broader bull market, not indicative of a broader recession," Liz Ann Sonders, chief investment strategist at Charles Schwab, said in an interview. "In terms of the averages, we've had much sharper corrections inside the market at the industry level, the individual company level. You can't just look at what the averages are telling you."
If it's true that the market hates uncertainty, than the Federal Reserve is on its way to becoming public enemy No. 1.
Wall Street can't seem to make up its collective mind about when the U.S. central bank is going to start raising interest rates, with strategists and economists stuck on September and traders focused on a later date, possibly not until 2016.
The latest salvos in the intensifying debate came from Citigroup and JPMorgan Chase, both of which opined Tuesday that the first rate hike in nine years likely will come next month.
"Notwithstanding the declining probability for a September move priced in the fed funds market, signs of market containment and lack of prolonged global systemic fallout implies the September timetable for a Fed liftoff remains," William Lee, head of North America economics at Citigroup, said in a note to clients.
Markets sensed relief Tuesday after a string of brutal sessions, but stocks could tumble again before truly bottoming out, according to one strategist.
Major U.S. averages spiked Tuesday morning in the wake of a three-day drubbing in which the Dow Jones industrial average lost nearly 1,500 points. But based on some key indicators, whipsaw trading could persist before stocks touch their lows, said Nicholas Colas, chief market strategist at Convergex.
"Our indicators show that U.S. equity markets are still in for more volatility in the days ahead," Colas wrote in a note Tuesday.
He outlined conditions that eight metrics may have to meet before stocks find "a near-term bottom."
U.S. benchmark WTI crude would need to avoid new lows for "at least a week," Colas contended. It plunged more than 5 percent Monday to settle at $38.24 a barrel.
"With a close at $38, oil is well below the $40 level we think divides market sentiment on a growing versus contracting global economy," Colas said.
The commodity rallied more than 3 percent in trading Tuesday, nearing $39.50 per barrel.
One of the year's most popular trades is losing steam in a hurry as the currency landscape suddenly looks a lot different.
Currency hedging had been the hottest thing going, with exchange-traded funds focusing on expected developments around the world attracting billions in investor cash.
But as dynamics change, the anticipation that the U.S. dollar would continue to strengthen against its global peers is in doubt, and so are the accompanying trade positions.
For instance, the euro has lost as much as 13 percent against the dollar in 2015 as forex traders bet that the European Central Bank would be easing its monetary policy as the Federal Reserve was taking actions to strengthen the greenback.
Market chatter about what the Federal Reserve's next steps will be suddenly has shifted from when it will raise rates to when it will offer more stimulus.
Mind you, no one believes the U.S. central bank is about to start printing money again anytime soon. However, there is talk that faced with a slowing global economy and a domestic market dependent on cheap debt, it's only a matter of time before the spigots get turned on once more.
"The Fed is not going to raise rates. They are at zero forever," said Peter Schiff, head of Euro Pacific Capital and one of the most well-known and impassioned of all the Wall Street Fed critics. "The Fed is not done with QE, they're just getting started. The Fed is doing QE4, QE5. This is a never-ending process."
The "QE" reference, of course, is to quantitative easing, the bond-buying program that added about $3.7 trillion to the Fed's now-$4.5 trillion balance sheet since late 2008. Three rounds of QE, plus the balance sheet-neutral Operation Twist, have helped boost the stock market dramatically, with the S&P 500 rising more than 190 percent off the March 2009 lows. But the impact on the real economy has been less tangible.
In addition to the previous rounds of QE, the Fed has kept its key interest rate near zero, holding down lending rates and keeping borrowing costs low for the $8 trillion in debt the government has added since the financial crisis.
Liquidity issues have been at the forefront of potential market pitfalls for months.
Banking analyst Dick Bove said Monday that investors could be about to see just how bad things can get.
As Wall Street suffered through another brutal trading day, the vice president of equity research at Rafferty Capital Markets asserted that liquidity, or the ability to keep cash flowing and match up buyers and sellers, is posing perhaps the biggest challenge ahead.
Bove said he hopes buyers step in to stem the damage. Otherwise, the consequences could be severe.
For years, Piper Jaffray has been one of the biggest bulls on Wall Street, and with good reason.
This week, though, amid market carnage not seen since the financial crisis, the firm has decided it's seen enough.
Piper finally slashed its uber-optimistic market call for 2015, cutting its S&P 500 price target from what now seems an unreachable 2,350 all the way down to 2,135.
"We no longer believe the odds are in our favor for the S&P 500 to reach our prior target of 2,350 by year-end, since history shows that recoveries from pullbacks/corrections have generally taken about two to four months to materialize," Craig Johnson, technical market strategist, said in a note.
The call comes as traders prepare for yet another day of carnage that could see the market's biggest drop since the darkest days of the financial crisis in 2008. Fears of a China slowdown turning into a global recession have caused a market tumble that could put an end to a six-year bull market.
The Dow industrials are in a full correction mode, dropping more than 10 percent from their highs, while multiple S&P 500 sectors are there as well.
Key support levels ahead for the latter index are 1,905, a 3 percent drop from Friday's close, and then 1,820, a violation of which "would alter the longer-term uptrend of the broader market."
The Fed rate hike derby keeps getting more and more intense.
A growing consensus of market experts—particularly economists and strategists—believes the Federal Reserve will increase rates in September for the first time since 2006. Traders in fed futures, though, tell a different story.
Probability for a move next month plunged to 24 percent Thursday as gauged by the CME's FedWatch barometer. That's off from 45 percent the day before and reflective of sentiment after the minutes of the Fed's July meeting hit the tape Wednesday. (Tweet This) Central bank officials appeared torn between hiking and staying put as they praised the strength of the job market but worried over persistently low inflation.
October's chances for a hike plummeted from nearly 50 percent to 32 percent, while December went from about 73 percent to 59 percent.
Overnight indexed swap rates also argue against a rate rise, with traders assigning a 32 percent chance to such a move even after positive economic data Thursday.
But hold on: The consensus is far from settled. Multiple Wall Street experts continue to think the Fed will move in September, with some contending one factor is simply a desire to get it out of the way and stop the endless back-and-forth debate.
The Federal Reserve got a little more breathing room Wednesday from the push to raise interest rates in September.
A widely followed inflation gauge—though not the Fed's favorite one—showed that outside of rising rents, there was little price pressure in the marketplace. The consumer price index rose just 0.1 percent in July. Even excluding food and energy prices, the CPI was only up the same 0.1 percent.
On an annualized basis, the index rose just 1.8 percent, which is below the Fed's current 2 percent inflation target.
Tumbling energy prices are the root of the CPI's weak performance, with the overall sector down 14.8 percent over the 12-month period, though up 0.1 percent for the month. One of the the more notable increases came from rent, which rose 0.3 percent in July and 3.6 percent for the year. Airfares plunged 5.6 percent, the most in 20 years, and fuel oil fell 3.4 percent in July.
Viewed together, the data take still more of the steam out of an argument for the Fed to raise rates in September for the first time in more than nine years.
Ray Dalio's fund slumped in August and some investors blame the strategy of such funds for the volatility that slammed stocks and commodities.
For all the talk about the 250,000 jobs a month the economy is creating, workers' real wages are going backward.
Volatility could probably last anywhere from three to four months, Brian Jacobsen of Wells Fargo said.