Monday, August 04, 2014

Too Early To Worry About Correction

WALL Street’s worst week in two years was enough to get investors worried about whether a long-overdue correction is coming, but analysts are still leaning bullish. 

The S&P 500 ended the week down 2.7 per cent, its biggest weekly loss since June 2012, a decline that had followed several weeks of selling. 

The market is undoubtedly ripe for a correction — the current rally has continued for nearly three years without a decline of more than 10 per cent. 

The United States Federal Reserve looks closer to raising rates, and housing and auto sales figures suggest those markets may be softening, if only temporarily. 

“The summer has been just tough because there has been very little to buy,” said Kathleen Gaffney, portfolio manager of the Eaton Vance Bond Fund. 

“But I think what is happening is we are seeing the markets adjusting from an environment of lower interest rates to higher interest rates — and that’s producing volatility.” 

The Fed’s monetary policy has been favourable for the markets, and though it is expected to begin raising rates next year, the absence of wage pressures has kept moves in Treasuries yields relatively muted. 

While the spread between long- and short-dated Treasuries has narrowed of late, which tends to happen as the economy slows, the difference between the two-year and 10-year Treasury notes is more than two percentage points — still a favourable sign for economic growth. 

On Wednesday, the Fed gave a rosier assessment of the US economy while reaffirming that it is in no hurry to raise interest rates. 

The US central bank also, as expected, reduced its monthly asset purchases to US$25 billion (RM80.28 billion) from US$35 billion. 

Although government data on Friday showed US job growth slowed last month and the unemployment rate unexpectedly rose, recent economic data has been largely positive with growth in second-quarter gross domestic product at four per cent and favourable revisions to first-quarter gross domestic product. 

The CBOE Volatility index, Wall Street’s so-called fear gauge, jumped to 17.03 from 12.69 after Portugal’s Banco Espirito Santo reported an unexpectedly large loss for the first six months of the year that raised concerns about the bank’s solvency and after US employment cost pressures came in higher than anticipated. 

But the VIX remains well under the long-term average of about 20, and stock valuations remain reasonable. 

The S&P 500 is trading at an average price-to-expected earnings ratio of 15.4, which is not very stretched relative to the historical average of around 14.1. 

“The economic environment remains healthy. As such, volatility should decline and stocks should rebound,” said Jonathan Golub, chief US market strategist at RBC Capital Markets. 

Even so, the fact that the benchmark S&P 500 hasn’t been able to crack the 2,000 milestone, despite a few approaches, suggests some exhaustion is setting in. 


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