What’s behind the sell-off and why it may signal a bigger correction

Published Mon, Jul 19 20211:24 PM EDTUpdated Mon, Jul 19 20214:29 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Some stock strategists say Monday's market sell-off, triggered by a Covid-inspired global growth scare, could be the start of a bigger correction of 10% to 15%. Worries that Covid variants could impact the global economy spurred a sell-off across the world's stock markets. The Dow fell 725 points, about 2.1%. The 10-year benchmark Treasury yield , which has been moving lower for weeks, slipped below 1.2%. "Investors are looking at it as a canary in the coal mine," CFRA chief investment strategist Sam Stovall said of the drop in bond yields. The 10-year hit a low of 1.17% Monday fromj just about 1.3% Friday, its lowest level since February. Yields fall as bond prices rise. The S & P 500 was off 1.6%, ending the day at 4,258. Stovall said the correction in the S & P could be as steep as 10% to 15% and could reach its 200-day moving average at 3,895. "It probably will end up not being a pullback but a correction," Stovall said. "A meaningful correction, not a new bear market but a meaningful correction [in stocks] that will adequately reset the dials." A flagging rally Earlier, Morgan Stanley chief U.S. equity strategist Michael Wilson said in a note that the rally showed signs of being exhausted , and investors should shift to defensive sectors. He said the market is in a transition and could hit a 10% to 20% correction. BTIG's Julian Emanuel, said in a weekend note that his base case a test of the 4,000 level on the S & P 500 before the end of the third quarter and possibly the 200-day moving average. The 200-day is a closely watched technical measure, which is basically the average of the last 200 closing levels. It can be a level of support. "Bond investors are certainly questioning the reopening, and we got a sense of that even before," said Jack Ablin, chief investment officer at Cresset. "Certainly, there is legitimate concern, but I think when we get to the other side of the hill, we will get back to whatever it is, a stable state, I still think interest rates are just way too low." Ablin said his model shows the potential for an 11% stock market correction. "To me, I wouldn't use this as a signal to get out. Certainly there's peak growth, peak profits. ... I do think it's a correction. I would be concerned if I started to see credit spreads widen and lenders starts to choke off credit which we're not seeing at all." Growth peaking? The economy is expected to have grown by about 9% in the second quarter and 7% to 8% in the third quarter. Corporate profits are also expected to have peaked in the second quarter, with a gain of more than 65%. Some of Monday's biggest declines were in cyclical stocks that had benefited from the reflation trade. Oil plunged more than 7% after a 7% decline last week. Energy stocks lost 3.6%; financial stocks were down 2.8% and industrial stocks fell 2.1% Monday. Treasury yields, which move opposite to price, have been flashing a warning for several weeks. The decline was also blamed on concerns that inflation would force the Federal Reserve to reverse easing policies sooner than expected, and that could also crimp growth. Steve Sosnick, Interactive Brokers chief strategist, said he doesn't know if the pullback is signaling a correction, but it is a sign that investors are viewing the market differently. "What we're seeing today is forcing people to reprice things. When that happens I think you're less likely to get a snap back rally than when it's a garden variety overbought," he said. "I think that's the difference today than some of the other dips we've seen. This could be a little more lasting. But I'm not saying sell everything and head to the hills." "I think today you're seeing a change in the narrative that people are using to make their pricing decisions. I think it depends on Covid," Sosnick said. "It depends on some more clarity from the Fed. I think it depends on some more clarity from Washington, the infrastructure bill." "The question is, 'What's your next catalyst?" he asked. "The bond market is telling you the catalyst is lower growth, flight to safety, deflation. ... Take your pick. None of them are market friendly. It's the worst of all buffets."

Traders on the floor of the New York Stock Exchange, June 4, 2021.

Source: NYSE

Some stock strategists say Monday's market sell-off, triggered by a Covid-inspired global growth scare, could be the start of a bigger correction of 10% to 15%.