Just when people think that US is impervious to the problems that has plagued the Emerging Markets since the start of the year, the day of reckoning finally came as the US stock market joined the Europe and Emerging Market counterparts and plunge into correction zone.
The first question investors have been asking since the start of the fall - "Is this the start of the bear market?" Let us look at some market indicators to help us estimate how far we are in the economic cycle.
US Treasury Yield Curve
The US treasury yield curve is a comparison of the interest rates offered by bonds of different maturity. The longer dated bonds typically give higher interest as it pays investors more for the higher risk they take for depositing the money with the US government. An inverted yield curve is when the short term interest rates is higher than the longer dated bonds and that is often due to a combination of a rising interest rate and investors buying into longer dated bonds to protect against possible recessions. History has proven that an inverse yield curve is almost accompanied by a bear market and recession down the road. As of now, the yield curve is very flat meaning that we are near to the end game with perhaps a year or two before the dam breaks and becomes inverted. This makes professional investors very very nervous, but not enough to throw in the hat yet.
Unemployment Rates
The other important indicators of a bear market is the unemployment rate of a country, and in this case, the all important US unemployment indicator which is a barometer of the health of the US economy. History has shown that recession is always preceded by an uptick in unemployment upon hitting a cycle low as companies' profit start to fall and they start to slash headcount to preserve their profitability. The recession will normally accelerate the retrenchment process leading to a sharp uptick to the unemployment rate. At this moment in time, unemployment rate in US is at a record low and is still ticking lower. Any signs of an increasing rate of unemployment will signal that this market cycle is near its end.
Demand for Commodities
Ever since the commodity market crash in 2016, bringing down the stock market of China and major emerging markets, the sector has been seeing a healthy uptrend since than. This trend is often illustrated by the Baltic Dry Index which measures the cost of bulk shipping around the world and is a reliable indicator of the demand of raw material around the globe. As of now, the trend is still a healthy uptrend but it is reaching the peaks 2014 again.
Conclusion
Is this market correction the prelude of a major bear market and we should be selling off everything and bunker down? The answer in my opinion is "No". However, we are seeing that volatility is normalizing after years of ultra low interest rates and easy money. We will see bigger dips in the stock market and 10% will be a norm in the period to come. Previously, it is not uncommon to see 10% corrections in the US stock market on an annual basis and it is only in this cycle that we see a 10% market correction this year as interest rates normalize. Having said that, I believe that the economic cycle is near the end with a year or two left to go and these three indicators are the ones to watch as the early warning alert on an incoming economic ice-berg.
Portfolio Strategy
The portfolio has performed well in the face of the market correction with a dip of 4% as compare to the global market with a 7% drop. The drop will be lower if not for the sudden fall in gold and oil prices, dragging down First State Global Resource. The correlation between commodity and equity hasn't been this high since 2016 and the attempt to diversify from the equity market failed for this instance as the intense selling took out the commodity markets as a result of fear of a weakening global demand and covering of losses in technology stock using the more resilient commodity stock. Having said that, with inflation creeping back and oil sanctions looming in Iran, the strength in the commodity market will continue and rebound from this episode quickly. Another event to look out for is the G-20 summit in November whereby investors are hoping that US and China and come to an agreement to put a halt to the on-going trade war. This event will definitely give a push to the global equity market if it comes out well.
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