Yesterday the US Equities markets dropped again with the Dow Jones Industrial Average posting a -1.29% return with the NASDAQ down -1.58% by the close. My position this week is a generally sideways move, but if this continues for a few days I might even get caught off guard.
So what’s causing this weakness?
One of the major driving forces behind the US Equities market since 2009 has been the central bank intervention in the form of Quantitative Easing, or QE. This central bank intervention caused a magical v-shaped recovery in the post crisis years, almost certainly on account of asset price inflation:
This of course coined the phrase buyer of the dip (to double down on stocks when the market moved lower and then sell into the market when the Fed. intervened).
What is QE?
Quantitative Easing is simply shifting “non-performing” assets (which, in my estimation would just be a liability, but whatever floats your boat I guess) from commercial banks and pension fund balance sheets to the central bank’s balance sheets. This has net affect of injecting cash (liquidity) into the markets, while reducing the supply of “assets”, causing the magic levitation.
In short, the market has been primed over the last five years to think that every time there is negative shock to the market, it will rebound a week later when the central banks step in.
And note: this isn’t just the US Federal Reserve. This policy has been carried out by central banks like the PBOC (China), the BoJ (Japan), the ECB (Europe). They’ve all been passing the policy canteen, to paraphrase Jim Rickards, as it were.
Unfortunately for the market bulls, the policy seems to have run its course. The Fed., risking losing credibility altogether- a “the emperor has no clothes” moment, which they cannot afford, has been forced to rate interest rates.
What’s around the corner?
The Fed. has pledged to continue raising interest rates over the course of 2016, and I expect that they will do so. I also expect lots of Forward Guidance from the global central banks over the course of the next year (which is essentially just steering the markets with various public statements.)
This is basically what Mario Draghi did last week on Thursday, likely assisted by some other market participants, sending the markets rallying toward the weekly close.
Obviously, Forward Guidance only works as long as confidence in the central banks is maintained. Which is why they are often like a poker player, bluffing the table and need to occasionally follow through on promises.
Either way I expect in 2016 the prevailing “buy the dip” sentiment amongst the casual investors might finally get “old yellered”. I wouldn’t call this the start of a major bear market in US stocks (though I cannot comment on the Shanghai Composite), but this current slump will have legs.
What to watch?
Aside from the weakness presenting itself in the form of the 16th Dec. Fed. Reserve rate hike, there are cracks starting to develop in China. Of course, it’s all related, but more on this later.