- The stock market on Thursday slumped into a correction.
- “I’ve been doing this job for 22 years, and it just doesn’t feel like we’ve hit a bottom yet in terms of this correction,” said John Herrmann, a rates strategist at MUFG.
- Investors may be awaiting more clarity on US inflation, and how it could impact stocks, he said.
- The sell off coincided with a changing of the guard at the Federal Reserve, which could respond by raising interest rates faster than markets expect.
This stock-market correction may worsen.
Less than a month ago, the big story was the “parabolic” move that was lifting stocks to new highs and keeping volatility at historic lows.
“I’ve been doing this job for 22 years, and it just doesn’t feel like we’ve hit a bottom yet in terms of this correction,” said John Herrmann, a rates strategist at MUFG Securities.
At issue is whether the market is being driven by an inflation outlook that could hurt stocks, or by a technical correction involving the unwinding of low-volatility trades that had become very crowded.
This episode of weakness began last Friday, after a stronger-than-expected report on wages sounded the alarm on higher inflation. On Monday, the Dow plunged nearly 5% (over 1,000 points). But the drop was far worse for exchange-traded notes designed to short volatility like the VelocityShares Daily Inverse VIX Short-Term ETN (XIV), which many traders had invested in to profit from calmer markets. Not only were traders closing their short positions, but some were actively buying volatility, triggering a spiral that helped push stocks lower.
On Thursday, however, investors appeared to be more focused on the bigger picture — and it didn’t look great for stocks.
“The troublesome point for the equity market is we’ve corrected a good amount, and normally that would be followed by some fairly dovish Fed speak,” Herrmann told Business Insider.
“Yet, the economic and inflation data may be resilient enough that it forces the Fed’s hand to continue to raise rates this year, even though equities are turbulent.”
As for when the selling could pause, Herrmann suggested that traders might be waiting for more clarity on US inflation. Next Wednesday’s scheduled release of the Consumer Price Index for January could be an important guide.
Another headache for markets is that the central bank’s interest-rate moves may now be less predictable, according to Larry Hatheway, the chief economist at GAM Investments. During much of this recovery, investors could count on a low rate environment, or at least, slowly rising rates.
“Once you begin to doubt whether inflation has reached a tipping point, the Fed’s predictability is in question,” Hatheway told Business Insider. “It’s a question nobody posed a few weeks ago. This begins to erode one of the qualities that had moved equities higher.”
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