FTSE 100 recovers from worst levels as Dow opens 300 points higher – as it happened

US benchmark share indices falling into correction territory (down over 10% from record highs) has ignited concern the bull market has ended. There has been a spike in volatility, which has resulted in a blow-up in low-volatility strategies and a sharp dive in negatively correlated US index ETFs. The question is whether this is the technical trigger for wider market contagion or just a long overdue “healthy” pullback for an over-extended market.

We would make the point that the stock market can deviate massively from economic fundamentals in the short term. Fear of rising bond yields can easily produce a bear market (down 20% from 52-week highs) despite a healthy global economy. In fact, that is usually how it happens because the stock market is a future-discounting mechanism. Another argument for a bigger move lower is that much of what has helped keep the stock market moving higher is momentum, which is now reversing. We would liken the outlook for the US stock market to making a tackle in sports, “the bigger they are the harder they fall.”

A 10% market correction historically happens on average every 18 months, marking it a very “normal” phenomenon. The key point this time around is that market conditions since 2009 have been very abnormal thanks to unprecedented central bank support. We would interpret these latest market moves as a part of a significant transition. It is most likely a transition to a more “normal” resumption of the bull market with higher volatility but the risk of it being a swift transition to a bear market should not be underestimated. We maintain, but are more cautious of our year-end forecast of the S&P 500 at 2,900.

Right now, there is a ‘shake out’ taking place as bulls and bears battle for dominance. The Dow Jones has found near term support above 23,000. We suspect more mean reversion will take the Dow below its 200-day moving average near 22,850. In conclusion, it may be a bit early to buy the dip but wild swings, potentially as high as 26,000 will provide ample opportunities for day traders.

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