Is it the beginning of the end?

The Fed is going loco, President Trump claimed

Hussein Sayed, OpinionIndustry Expert
Hussein Al Sayed is the Chief Market Strategist for the Gulf and Middle East region at FXTM, and host of the popular evening business show on CNBC Arabia, Bursat Al Alam. Prior to his current role, Hussein spent many years working in the finance sector as a dealer, trader and analyst in equities, credit and foreign exchange markets. He holds a BA degree in Banking and Finance from the Lebanese International University and is experienced in both technical and fundamental analysis.

October 11, 2018

On Wednesday, United States equity markets suffered their worst sell-off since last February. Volatility spiked 44 percent, trading at levels last seen in March. Treasury yields retreated slightly with 10-year bond yields sliding 10 basis points from a 7-year high. Growth stocks were hit hardest with a sell-off in Tech companies dragging the Nasdaq Composite down 4.1 percent. The Dow Jones Industrial Average and S&P 500 were not far behind falling 3.15 percent and 3.29 percent respectively.

Has the Great Bull Market reached its end?
So many voices may begin suggesting that the longest bull market in history has come to an end. However, we experienced a worse sell-off last February when the S&P 500 fell more than 10 percent in - “correction territory” during seven trading days. Back then the blame fell on strong economic data after wage growth grew 2.9 percent, suggesting that inflationary pressures were building, and the Fed would need to tighten monetary policy faster.

This time around it doesn’t seem a lot different. The only difference is that the reaction to higher interest rates was a little delayed. Bond yields have spiked 40 basis points on the 10-year Treasuries since the beginning of September. This has called into question the valuation of many growth stocks, particularly Tech. It shouldn’t be very surprising to see this kind of reaction when the required return of equity, a key component in equity valuations, soars in a short time frame.

So far, we may describe the sell-off as profit taking with many investors reconsidering their asset allocation weightings in their portfolios. Some investors will also be watching key technical levels, given that the S&P 500 is testing the 200 days moving average. This key support level has been tested three times in 2018 and managed to bounce again higher. However, a close below for two or three days may intensify the sell-off for a couple of more days.

"The problem in my opinion is Treasury and the Fed. The Fed is going loco and there's no reason for them to do it. I'm not happy about it", said U.S. President Donald Trump.

While I agree with President Trump that Wednesday’s sell-off is the fault of the Fed, he should be reminded that the trade war he started with China and re-imposing sanctions on Iran is also to blame. His actions helped build inflationary pressures and the Fed cannot stand still when it sees the economy overheating. A steeper sell-off in equity markets will probably lead to a pause in hiking rates, but the Fed will be more concerned about the overall economy performance than just equity prices.

Now it’s up to the earnings season which kicks off on Friday to convince investors that earnings are still robust and the outlook is rosy. If corporate America paints a gloomy picture due to trade disputes, higher import prices, a stronger dollar, and other variables, this will confirm that stocks have topped out for 2018.

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