Prices don’t change when fundamentals change. Prices change when expectations change
The world does not become heaven in Bull market or Hell in bear market. The world remains the same. The only thing that differentiates bull market versus bear market is how market participants look at the market. When they view it as Glass half full - market rallies and when they see it as half empty - market tanks.
If you want to understand market - think what's driving the market as of now and what is shaping its thinking.
What's driving Global Financial Market right now? - Huge Rally in USD Index.
The Dollar index yesterday closed at 99.79, level not seen in 12 years.
There has been lots of discussion around collapse in crude prices but this chart i.e. Dollar index never got the attention it deserves. I have been talking about rally in Dollar index since it was at 84 and warning about it but it seems market has taken note of it now when its knocking the door of 100.
The Breakout move above 89 has been very sharp. I did tweet about it just when the breakout was happening...
S&P500 for first time now has recognized the risk strong dollar poses to US corporate and economy, and that's why US market sharply corrected from highs
Here's S&P500 Daily Chart
The Big question: where is the support? The 200 dma stands at 2001 but visually support appears at 1980-1990.
The risks that come from Strong Dollar
Strong Dollar = Lower Corporate earnings for Large US multinationals. It is bad for both - companies that exports and companies that operates in foreign countries and generate earnings in lets say Euro, or Yen. As per some estimates, roughly 30% of S&P 500 sales comes from foreign markets. That's why lots of US companies blamed strong dollar for last quarter bad performance. As per EPS forecasts compiled by FactSet, S&P 500 earnings are projected to decline by -2.8% YoY in the first quarter of 2015, immediately followed by a decline of -0.7% in the second quarter. Just look at how much earnings expectations have come down -
"On September 30, the estimated earnings growth rate for Q1 2015 was 9.9%. By December 31, the estimated growth rate had declined to 4.2%. Today, it stands at -1.6%." ~ Businessinsider.com
Strong Dollar = Emerging market pain. What happens to all the dollar denominated debt taken by EM borrowers? As per some estimates - “emerging market borrowers had issued a total of $2.6tn of international debt securities, of which three-quarters were denominated in dollars." No wonder MSCI EEM shows no sign of recovery
US Markets (Large Caps) are not cheap either
The forward 12-month P/E ratio for the S&P 500 now stands at 16.6, based on yesterday’s closing price (2040) and forward 12-month EPS estimate ($122.72). The current forward 12-month P/E ratio of 16.6 is now well above the three most recent historical averages: 5-year (13.6), 10-year (14.1), and 15-year (16.0).....Factset
Everything is measured against expectation. Right now, US economy is doing very well. The US economy has seen robust GDP growth over the last three quarters. GDP increased by 4.6% in 2Q14, by 5% in 3Q14, and by 2.2% in 4Q14. It's adding jobs at pace not seen for many many many years. But all that seems factored in the price as of now. Having said that, Market has not lost its rationality. Just look at small cap index in US i.e. Russel 2000. It has started to outperform S&P500
Strong dollar will not hurt small US economy focused companies. Fundamentally, these companies will benefit from a growing US economy
Are we looking at Big Global market correction?
Well Nobody knows. My only concern: Amazing complacency. Most of the market commentators have shrugged off this correction in S&P500 as minor pullback. Really? Market always moves in a direction that causes maximum pain. The question we need to ask: which directional move will cause maximum pain right now? I will be on side of caution right now. Always remember Murphy Law. It kicks into action only when things start turning for worse...
If anything can go wrong, it will; and will go wrong at the worst possible time.
If there is a possibility of several things going wrong, the one that will cause the most damage will be the one to go wrong.
Disclaimer – The state of the market notes is Deepak’s perspective on the market. The column is purely for educational purpose. Nothing contained herein is a solicitation to trade or a recommendation of a specific trade. By reading this publication you agree to make no trade relying in whole or in part on the comments of the writers