Wall Street suffered an ugly close, putting an end to an overall torturous week on Friday that sent the Dow Jones Industrial Average into its first 10% correction since 2011. After a year-long stasis near the $18,000 level, the Dow Jones’ collapse to $16,459 has come as a shock, pushing the CBOE Volatility Index (VIX) to its best weekly gain ever.
The catalyst: a weaker-than-expected Chinese manufacturing activity report, which dropped to its lowest level since March 2009 after six straight months of contraction.
In the end, the Dow Jones lost 3.1%, the S&P 500 Index lost 3.2%, the Nasdaq Composite lost 3.5% and the Russell 2000 lost 1.2%.
Pretty much everywhere you looked it was a bloodbath. The S&P 500 lost critical technical support at the 200-day moving average and the $2,000 level — putting its post-2011 uptrend in jeopardy. Crude oil dropped below the $40-a-barrel level on Friday for the first time since March 2009 on anticipation of seasonal refinery shutdowns and another expansion in drilling rig counts.
That lifted the ProShares UltraShort Crude Oil (NYSEARCA:SCO) — recommended to Edge subscribers — to a gain of 103% since recommended on May 26. The rise in the VIX was captured with a 66% month-to-date gain on the Velocity Shares 2x VIX (NASDAQ:TVIX) position.
Individually, popular tech stocks were in the bears’ crosshairs. Apple Inc (NASDAQ:AAPL) lost 6.1%; Google Inc (NASDAQ:GOOG, NASDAQ:GOOGL) lost 5.2%; Microsoft Corporation (NASDAQ:MSFT) lost 5.7%; Facebook Inc (NASDAQ:FB) lost 5%; Amazon.com, Inc (NASDAQ:AMZN) lost 4.1%; and Netflix, Inc (NASDAQ:NFLX) lost 7.6%.
Globally, the Shanghai Composite lost its 200-day moving average — a critical measure of the long-term trend — after authorities had vigorously defended the line in the sand since early July. Bourses from Japan to Germany are all wilting. Treasury bonds and precious metals have been on the rise as investors seek safe havens. And currencies of emerging market countries from Vietnam to Kazakhstan are under pressure.
The PowerShares U.S. Dollar Bullish Fund (NYSEARCA:UUP) lost its 200-day average for the first time since last summer. The yen and the euro are rising, despite aggressive stimulus efforts by the Bank of Japan and the European Central Bank, as popular currency “carry trades” are slammed.
There is no single driver for the decline, but a number of factors that have combined in the context of what had been quiet calm in the U.S. stock market.
There’s been a multi-month decline in market breadth, as fewer and fewer U.S. stocks participated to the upside. Corporate profitability has been pressured by slowdowns overseas, the stronger dollar, a tightening job market and lower energy prices. China has seen a marked slowdown in its economic data, as well as suffered a 32% stock market decline and a surprise devaluation of its currency last week.
Greece is back in the news as Prime Minister Alexis Tsipras has stepped down ahead of snap elections. And tensions are building on the Korean peninsula, as North and South Korea exchange artillery fire.
But above all else, this week’s decline seems to have been driven by concerns surrounding the approach of a potential Federal Reserve interest rate hike on Sept. 17. We’re in the midst of “hike havoc” — not unlike the “taper tantrum” of early 2013 as former Fed Chairman Ben Bernanke considered the beginning of the end of the QE3 bond purchase stimulus program.
Will the Fed ignore building financial market turmoil or be pressured into waiting?
The Fed seems to be tilting towards an earlier rate liftoff with a pause afterwards (the “one and done” scenario for 2015). Yellen has tried, unsuccessfully, to play down the importance of liftoff timing and has said that wage growth and inflation aren’t a precondition for the initial rate hike.
St. Louis Fed President, James Bullard, who famously saved the market back in October during the Ebola-driven selloff by reassuring investors that the Fed could unleash more stimulus if needed, also raised expectations of a September hike today when he said the Fed doesn’t react directly to equity markets, and that he’s more optimistic about the global economic outlook than the market is.
But the last time the Fed faced a cliffhanger decision, it blinked.
Bernanke delivered a surprise “no taper” decision at the September 2013 policy meeting; postponing the taper until December, just three months before current Fed Chairman Janet Yellen began her term.
Will Yellen fold too? The drop in the dollar suggests currency traders believe she will.
Yet the selloff in pretty much everything else suggests a nagging fear that the world’s most important central banker is about to turn hawkish, focusing on steady job gains and stable gross domestic product growth, while ignoring the market rout. According to Oxford Economics, the U.S. economy is growing at a 3% annual rate.
Capital Economics believes the Fed has set a “pretty low bar for a rate hike,” and with GDP growth likely to be higher than the Fed’s June projection they not only “think that the Fed will raise rates in September, but there would appear to be a good chance of a second hike in December as well.”
Much depends on the strength of the August jobs report on September 4, which will be the last before Yellen’s fateful decision.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
