Market Insider

UBS strategist Julian Emanuel sees start of 5 to 10 percent correction

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The stock market's broad-based decline Tuesday is most likely the start of a bigger 5 to 10 percent sell-off, according to Julian Emanuel, UBS equity and derivatives strategist.

Stocks swooned Tuesday amid worries that Republicans in the House of Representatives will not be able to repeal Obamacare in a vote Thursday. If that vote fails, analysts say it casts doubt on the timing for the passage of other pro-growth policies, supported by President Donald Trump and the GOP.

"It's pretty easy to see this as almost a risk reset. That's what we've been looking for and we think you are in the midst of it," he said. "To us the most important things going forward are two things — can confidence figures be maintained where they are now, and will the public continue to be the incremental buyer? If either one of those degrades at all, that opens up the case for more downside."

Emanuel said if the House does pass the bill, there will likely be a relief rally but he still expects stocks to be in a corrective phase. The doubts surrounding the health-care bill do reinforce his view that tax reform will be late this year or next year. The administration has been hopeful it would be adopted by Congress before its August break.

"We've been saying that we expect a 5 to 10 percent correction. We've been saying that for weeks now," said Emanuel.

He said the market is also responding to the Fed's interest rate hikes and the decline in oil. When the central bank has raised rates in a quarter with a low growth forecast, the market has sometimes taken a second look. He notes that the Atlanta Fed sees growth of just 0.9 percent this quarter.

The Fed also hiked in a low-growth period in December 2015. "What happened was the market began to question whether it was a policy error ... so for us there is unexplained softness in consumption that may or may not correct itself once the tax refunds get into peoples' hands but there's no signs that's going to the be the case," he said.

Emanuel said market valuations are stretched and many investors are too hopeful earnings will grow as much as 10.7 percent this year, boosted by some type of tax reform.

He also said the VIX, the CBOE Volatility Index, is too low and investors haven't hedged for volatility. The VIX rose 10 percent Tuesday to 12.47.