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A 2018 Stock Market Sell-off Could Be In The Cards For Year-End

By Michael KramerMarket OverviewOct 01, 2021 06:19AM ET
www.investing.com/analysis/a-2018-stock-market-selloff-could-be-in-the-cards-for-yearend-200603698
A 2018 Stock Market Sell-off Could Be In The Cards For Year-End
By Michael Kramer   |  Oct 01, 2021 06:19AM ET
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This article was written exclusively for Investing.com.

The FOMC meeting on Sept. 22 seemed to hold plenty of hidden surprises. The first surprise to many was the strong language from Powell at the press conference that QE would soon begin to wind down. The next surprise were the forecasts of a rate hike in 2022 and as many as four hikes by the end of 2023. Most of the markets have responded correctly, with the dollar surging and yields rising.  

The yield curve has shifted rather dramatically, with rates all across the curve rising from 2-years out, with a significant increase in the 2-year bill, which has now climbed by nearly eight basis points (bps) to roughly 30 bps. Meanwhile, the 5, 7, and 10-year rates have increased by 16 bps and more. 

Flattening Curve

The immediate impact was that the yield curve flattened, but the curve has started to steepen with the 10-2 Year Treasury Yield Spread increasing. But perhaps, more importantly, is that the yield curve overall has flattened dramatically since the early spring when the same spread was at nearly 1.6%.

10-Year Treasuries Daily
10-Year Treasuries Daily

It is a subtle but momentous change because the front of the curve is now rising, while the long end of the curve is not increasing fast enough. It is the bond market's way of suggesting that there will be a much more hawkish Fed in the future but for an economy that is likely not to grow nearly as fast. 

Surging Dollar

The dollar index appears to confirm the view of the yield curve, surging to its highest levels since the fall of 2020. It make senses for the dollar to strengthen if the Fed ends QE and shorter-term rates rise. It seems that the dollar is also preparing for a more hawkish Fed down the road. 

Dollar Index Daily
Dollar Index Daily

Equities Ill-Prepared

The equity market appears to be unprepared for this paradigm shift. The S&P 500's valuation is still at historically high levels, with the index trading around 20.5 times its next-twelve-month earnings estimates. While the PE ratio had come down from its peak of 23.5 in September 2020, it is still extremely high compared to historical levels. Over the last ten years, the index has had an average ratio of 16.6, and over the previous 20 years, it has averaged 15.7. The only period that replicates the current market multiple is that of the late 1990s. 

The valuation for the S&P 500 indicates the market is still expecting an ultra-accommodative Fed and solid economic growth. The yield curve suggests the exact opposite. The equity market appears it may finally be starting to catch on to this idea, with the index about 5% off its highs, but the multiple of the market suggests there is still a lot more downside risk to come. 

On top of that, it would seem natural for the equity market to resist a change in monetary policy from the Fed, especially one of this magnitude. The same scenario happened in the fall of 2018 when the Fed was on a course to continue raising interest rates. The market fought back against the Fed's monetary stance, and in the end, the equity market won.  

Rising bond yields and a strong dollar will signify that equity prices need to fall, and the more they increase, the more conviction the market has towards a more hawkish Fed. Throw in some slowing GDP growth, and this has the making for a 2018 like equity market melt-down.

A 2018 Stock Market Sell-off Could Be In The Cards For Year-End
 

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A 2018 Stock Market Sell-off Could Be In The Cards For Year-End

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Comments (14)
Kochar Bipin
Kochar Bipin Oct 03, 2021 5:18PM ET
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The glut of capital means that long term rates are unlikely to rise significantly from current levels.
Colonel Forbin
Colonel Forbin Oct 03, 2021 12:01AM ET
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Mr. October is calling tops again
Hokyun Park
Hokyun Park Oct 02, 2021 7:51PM ET
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This guy is a permabear. Nothing to see here.
SLM McKinney
SLM McKinney Oct 02, 2021 9:29AM ET
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Thanks for the insight
Jesus Iglesias
Jesus Iglesias Oct 01, 2021 10:21PM ET
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Michael... you always say the same words, every month, every year: "plunge", "rip", "dazed", "sink"... Reality:  S&P 500 doubles from its pandemic bottom
Rajkumar Basnet
Rajkumar Basnet Oct 01, 2021 12:50PM ET
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hello
Hiren Dagha
Hiren Dagha Oct 01, 2021 12:36PM ET
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You just keep on writing this type of articles , live in present and look at dow… its flying now…
Leo San
Leo San Oct 01, 2021 12:35PM ET
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“Could be” lmao! Im buying these dip.. spy drop under 20 and 50sma . Thats bullish since u buying in cheaper.. buy low sell high. I dont buy green, i buy on red days this!! Weather i do intraday or semi-lonng term. I always buy red for a bull/bounce play .
Billy Bilnaad
Billy Bilnaad Oct 01, 2021 12:34PM ET
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Omg here he goes again spreading fud.
MuraliKrishna Brahmandam
MuraliKrishna Brahmandam Oct 01, 2021 10:22AM ET
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looking down from 120th floor is scary. you can fall all the way to ground
Richard Sullivan
Richard Sullivan Oct 01, 2021 10:22AM ET
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