Warning Signs Suggest a Possible Stock Market Correction on Its Way
Reforms implemented after the financial crisis of 2007-2009 have strengthened the financial system without hurting economic growth, said Janet Yellen. The Federal Reserve Chair used vague language after one of the most anticipated meetings of central bankers in years at Jackson Hole, Wyoming. She was probably trying to prevent a September stock market correction.
The atmosphere remains particularly cautious as the Jackson Hole gathering gets under way. This is the traditional annual meeting of the world’s leading finance influencers. These are not mere “social media” influencers. What they say in 140 characters or less can make markets fall or rise. Many fear a stock market correction coming anytime.
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Investors know that such international gatherings often don’t deliver final decisions. But they send strong signals as to where policy is heading. In this case, the heads of the world’s largest central banks were supposed to have delivered strategic information. Instead, the meeting has so far left analysts and investors hungry for details to predict when the stock market correction of 2017 will arrive.
Also Read: Stock Market Crash 2017? This Could Trigger a Stock Market Collapse
Janet Yellen and her European Central Bank counterpart, Mario Draghi, stayed silent about where interest rates are heading. Rather, I propose that Janet Yellen’s mute statement coughed up quite a bit of information. Understanding that any “louder” statement could have moved the markets, she did not want to raise the already high-risk load in the markets.
The Risk of Crash Is But a Small Interest Rate Hike Away
Had she hinted that interest rates were staying the same, Yellen would have triggered another, and much unnecessary, market rally. Stocks are already too high—or too expensive, if you prefer. They would reach a point where any correction would automatically trigger a crash. Consider that the mere avoidance of any references to monetary policy in this highly anticipated speech forced the dollar down. And of course, Wall Street continued its bullish its progression.
The opposite argument holds true had Yellen and Draghi sent a clear signal that the era of quantitative easing (QE) had come to a close. That would have sparked a sell-off that could easily have turned into a major market crash. Seasoned investors were not expecting big announcements, they were merely looking for the smallest indication of central banks’ strategies to reduce their debt, accumulated from years of QE and buying up bonds.
Seeing the risks, the fact that the world’s most observed central bankers have stayed mute on that key issue of interest rates is a signal in itself. Yellen and Draghi believe the present market performance to have exceeded reason and entered a region of pure speculative excess. They realize that either way, stable or higher interest rate news could not only cause a correction, but could have the power to trigger another 2008 financial collapse.
The nominal interest rate has become the kind of “black swan” that you can predict. Everybody knows the markets are floating on turbulent air. All it takes is one trigger, in either direction, to bring it crashing down. As the stock market corrections chart below suggests, these events are like small earthquakes that produce few and controllable damages.
Protect Yourself, Know How to Distinguish Correction from Crash
The stock market correction history suggests that such events give everybody time to reflect on the best course of action. History has also taught us that a market correction occurs when the market falls 10% from its 52-week high. A market crash, such as what happened in October 1929 and in September 2008, might also involve a loss of 10% from the 52-week high. But the key difference is that in a crash, stocks lose that much in a single day. (Source: “Identify Stock Market Correction vs Crashes to Protect Yourself,” The Balance, July 5, 2017.)
A market crash drives panic for days and discourages investors from buying. The same bearish attitude spreads to areas of the economic landscape beyond the financial exchanges. It affects overall business. People become more risk-averse and stop investing in economic activity in general.
That’s why jobs are lost and jobs growth comes to a standstill. Instead, a market correction gives many investors the chance to buy some coveted stocks at a discount. A real market correction can be identified by the speed and intensity with which share values return to their highs. Typically, a correction cycle might last three months. (Source: Ibid.)
Also Read: Warren Buffett Indicator Predicts Stock Market Crash in 2017
Central bankers are now balancing a delicate situation. They can trigger a market crash now, or they can delay it with the risk that the fall will be from loftier heights, meaning that the shock and losses will be bigger. Or they can attempt to trigger a market correction to let the bubble—especially the tech bubble—deflate gradually.
The problem is that the markets are more fragile now. Apart from the delicate maneuvers that central bankers must perform to maintain an equilibrium, they must also deal with potentially bigger risks. President Obama, who started his first term in the White House in the shadow of the 2008 crash, put forth reforms to act as shock absorbers against the vagaries of the markets.
The reforms adopted after the financial crisis of 2007-2009 were meant strengthen the financial system. The intent was to make the whole system better able to absorb shocks by targeting the causes of excessive speculation like the subprime bubble. They did this by limiting banks’ ability to speculate. By the late 1990s, President Clinton had lifted restrictions on commercial banks from being able to invest to cut speculative trading. The legislation in question was The Dodd-Frank Wall Street Reform and Consumer Protection Act and Trump wants to repeal it.
Thus, if a market correction doesn’t occur now, it risks being delayed to a post Dodd-Frank world. The risks will be bigger and so will the losses in the crash. Indeed, Yellen hinted against any “excessive optimism.” In my view, she delivered her verdict. She’s concerned about excessive market speculation and wants to slow it down.
