Why Wall Street Is Eyeing a Correction Coming Soon

Numerous strategists think things are getting dicey as we enter stocks’ lousiest month historically.


The correction chorus is getting louder. While this doesn’t necessarily mean a stock market downturn of at least 10% (that’s the correction definition) is imminent, the array and prominence of the Cassandras is worth noting. September is historically the worst month for stocks, and last week started things off with a 1.7% drop.

Julian Emanuel, chief equities and derivatives strategist at global financial services firm BTIG, is looking at an 11% downturn up ahead. The S&P 500 has been on a seven-month run, until recently, and Emanuel told CNBC this rally reminds him of 1999, right before stocks took a dive. “Be very much aware of the fact that if and when it reverses, the consequences could be severe,” he said of the market.

“The risk that the correction is hard is growing,” wrote Deutsche Bank equity strategists including Binky Chadha in a downbeat note, one of several compiled by Bloomberg. “Valuation corrections don’t always require market pullbacks, but they do constrain returns.”

Areas of concern on Wall Street are very high market valuations—a 31 trailing price/earnings (P/E) ratio—combined with lowered projections for economic growth, the ongoing coronavirus outbreak, and the Federal Reserve’s pending plan to taper its bond-buying spree. Right now, despite last week’s dip, the S&P 500 still hovers near its record. The index’s market cap is 175% of US gross domestic product (GDP), also a record.

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But another uneasy indicator is that since hitting its bear-market low in March 2020, investors are borrowing more. Margin debt has leapt 79% to $844 billion, data from the Financial Industry Regulatory Authority (FINRA) shows.

While not everyone is saying specifically that there will be a tumble of 10% or more, the negative outlooks are hard to ignore. “We are going to have a period where data is going to be weak in September at the time when you have a heightened risk of Delta variant and school reopening,” contended Andrew Sheets, cross-asset strategist at Morgan Stanley. The firm last week demoted US stocks to underweight.

“Global stock markets may be entering a period of turmoil,” predicted James Congdon, co-head of Canaccord Genuity’s research division Quest. And “while the broad US market outlook is solid in our central case, we think peak cyclical optimism in the US may be behind us,” commented Dominic Wilson, strategist in economics research at Goldman Sachs.

Corrections are rather frequent, coming once every 1.9 years since the middle of the 20th century, according to Yardeni Research. Since 1950, the market has been hit with a 10%-plus decline 38 times. Through last week, by the reckoning of Dow Jones Market Data, the S&P 500 has logged 214 trading days without a 5% downdraft, climbing more than 33%. That marks the longest period without a pullback since a 404-day stretch that ended in February 2018.

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The Amazing 10-Year Treasury and Its Slow-Motion Future

Why the benchmark bond is expected to rise, but at a sluggish pace.

The 10-year Treasury yield has been on the low side for months, despite talk of reignited inflation. Sure, it is going to go up, many forecasts say, but very, very slowly, amid rising prices and economic activity.

Goldman Sachs, for instance, predicts that the benchmark 10-year, now yielding just about 1.3%, will ascend to 1.6% by year-end—near its apex this year in March of 1.7%. That prognostication is down from Goldman’s previous 1.9% call. Longer-term, the firm still thinks the yield will grind north and finally, finally, breach the 2% mark in early 2023.

Even that pace has drawn considerable skepticism. “I don’t fully understand why consensus forecasts are anywhere near 2%,” said Steven Major, the HSBC Holdings global head of fixed income research, in a Bloomberg TV interview. That’s because, he said, the Federal Reserve doesn’t appear anywhere near close to bumping up rates, short or long. And the Fed dismisses the stunning jump in the 12-month Consumer Price Index (CPI) in July to 5.4% as a temporary aberration.

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To Joseph Lavorgna, Natixis’ chief economist for the Americas, the 10-year Treasury could go as high as 1.5% in 2021, with a lower end of 1.25%. “Whether this year’s inflation will persist depends on the outcome of budget negotiations” in Washington, D.C., he wrote in a research note. On the table in Congress is a $3.5 trillion budget bill to enlarge domestic spending and a $1 trillion infrastructure plan, which could pump yet more federal dollars into the economy.

The stunning deceleration of the jobs growth rate in August—just 235,000, about a third of what was expected—amid the surge in coronavirus infections and inflation makes him and others warn against any Fed moves to boost rates. Short rates have an effect on long ones, although it’s indirect, to be sure. Already, the Fed has signaled it will put off hiking short rates until 2023. And even that may be too ambitious a schedule. “It’s unlikely the Fed is going to hike any time soon,” Major said. “In fact, I would even argue that 2023 is too soon.”

Fed Chair Jerome Powell has indicated that the central bank will by year-end begin tapering its huge bond-buying campaign, designed to keep longer rates down. But Wall Street sentiment is growing that it will delay tapering for virus-related reasons: The economy might need that extra liquidity. A Bank of America report says the Fed might hold off if the Delta variant and anemic job growth persist.

Over the past decade, the 10-year yield has been generally above 2%, albeit not by much. The high point was 3.2% in November 2018, thanks to a post-election bump in the stock market, which drew investors away from bonds, dropping their prices (and in turn lifting their yields).

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