Markets sell-off may evolve into a prolonged scenario

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In Monday early trading, European shares fell by their most in nearly three months, hit by a global sell-off in stocks and bonds as investors seemingly fretted over the outlook for monetary policy in the United States. Last Friday’s sell-off on the global markets was a bit of a surprise, although not a completely unexpected one, with the DOW down nearly 400 points (2%).

Shares in the United States and Asian sunk as bond yields rose around the world. Investors seemingly fretted over a potential rate rise by the U.S. Federal Reserve next week, as they also questioned whether central bank policy had reached the limits of its effectiveness.

However, rumours and predictions about market crash have been building up for quite some time and the current sell-off may evolve into a prolonged scenario. You better watch and be ready with your buy lists by the end of the week as this could easily present buying opportunities.

Last Friday, Boston Fed President Eric Rosengren said the U.S. central bank could resume gradual rate increases as the risks facing the economy are more in balance. In addition, Fed Governor Lael Brainard unexpectedly announced she’d deliver a speech Monday. The markets responded with a swoon essentially falling all day with the DOW closing almost 400 points lower.

Will The US Federal Reserve Raise Rates?

The only real metric pushing the Federal Reserve towards a rate increase is the official US unemployment rate at 4.9%. Typically a level of 5% or less is considered full employment. Unfortunately, the labor environment today is not typical. Many people today are employed in jobs that are well below their training and/or skill level. Others are employed part time and some have dropped out of the labor market altogether. The 4.9% unemployment number does not take into consideration those factors. Surely the Fed understand this point as well as, and hopefully better than, the rest of us.

The rate of inflation is hovering around 1% which is well below the Fed’s 2% target. The latest GDP numbers were pretty anemic at a revised 1.1%. Both the manufacturing index and the services index took dives in the latest monthly reporting. There has been some speculation that the Fed wants to have a higher Federal funds rate before the next recession so they will have the means to juice the economy with lower rates.

Investors should expect to see a sharp drop in stock prices on Monday and possibly the next few days as the trading desks at the major banks and brokerage houses pull bids and let investors dump stocks until they find equilibrium price levels.

Typically, when speculative interest in the stock market waxes, the market goes up, and when it wanes the market goes down. Some market observers have been reporting lately that asset prices were indirectly manipulated higher by the policies of the Federal Reserve while stock prices were directly manipulated higher by high frequency traders and also by buyback programs of corporations.

Other keys to understanding the current level of speculative interest in the market relates to valuations. The US economy and the stock market continue to be on “life support” offered by pumping liquidity. Unfortunately, many other economies worldwide were not able to afford such generous “life-support” and are currently tumbling.

Another fact to consider is that the P/E ratios for US stocks are well above their historic norms while dividend returns on many stocks are abnormally low. The average P/E for the 450 stocks is about 32 while the average yield is about 2.3%.

Investors have been willingly assuming that somehow the economy will transition smoothly as the Federal Reserve withdraws its support. But that is a rather speculative wish that investors could possibly make because of imbalances in the economy which the Fed helped to create by pumping liquidity for a very prolonged period of time. Reexamining of such imbalances could easily become disruptive.

History shows that when bubbles burst markets don’t just correct, they crash. The root cause of each crash was usually deceptive business practices, excessive speculation and financial shenanigans in capital markets.

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