Top Story

Stocks struggle to sustain gains as risk of correction grows

After Monday’s sell-off, Wall Street opened sharply higher as downbeat tech names found support on “bargain” hunting and amid short-side profit-taking. However, the gains appeared to be short-lived as at the time of this writing, the major indices were coming off their best levels again. I still think a major correction could be on the cards soon, possibly in the coming days.

With US stock markets holding near their all-time highs and volatility being suppressed to record low levels, I just can’t help but feel investors are becoming unjustifiably complacent. Valuations have already become overstretched and at some point even the most bullish of market participants will have to accept that. A growing number of analysts agree that the bullish run cannot continue rising at this pace for much longer, at least without a sizeable correction of some sort.

One also has to remember that the number one reason why stocks are where they are is because of the unprecedented era of cheap central bank money flooding the financial markets. But with the Federal Reserve set to normalise its balance sheet, monetary conditions are going to tighten in the US. While the Bank of Japan will pick up the slack, a growing number of other central banks are turning or have already turned hawkish. The Bank of Canada has already started raising interest rates, while the Bank of England is set to do so in the coming months. The European Central Bank will likely announce the start of its own QE tapering soon.

As major central banks slowly unwind their government bond purchasing, yields should begin to rise. Rising bond yields will make the equity markets increasingly less appealing to yield-seeking investors. As a result, we may see the start of a bear market that could potentially last several months. For this thesis to be validated, though, we do need the markets to speak. So, any potential sharp sell-off going forward should be treated with more respect than has been the case in the previous years, because unlike then key central banks have started to tighten their belts now. 

From a technical perspective, the S&P 500 has already exceeded the measured-moved objectives from its long-term previous ranges, as indicated on the weekly chart, below. The benchmark stock index is also looking extremely overbought, as it hovers near the top of its multi-year bullish channel. Meanwhile the momentum indicator RSI is in a state of negative divergence with the underlying index, suggesting the bullish momentum is fading. While the markets could still push higher over time, the technical indications – and the abovementioned fundamental considerations – suggest that a correction is looking increasingly likely now.  

Source: eSignal and FOREX.com. Please note, this product is not available to US clients

Disclaimer: The information on this web site is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement. The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Losses can exceed your deposits. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that we do not provide any investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. References to Forex.com or GAIN Capital refer to GAIN Capital Holdings Inc. and its subsidiaries. Please read Characteristics and Risks of Standardized Options.