The Inevitable Correction

Mohamed El-Erian says the calls for QE4 (alt) are “understandable but misguided”: “the expected benefits [of QE4] would be small in terms of generating incremental growth that is both sufficiently durable and inclusive…QE4 is likely to face a very high implementation hurdle.  But this does not mean that Fed officials will stay on the sidelines.  Look for them to make calming remarks that seek to reassure markets.”  Meanwhile, Boston Fed President Eric Rosengren thinks the “Federal Reserve should address concerns of slowing inflation through the timing of its first hike of interest rates,” and that current “market turbulence might have more bearing on when liftoff would occur.”  Also, St. Louis Fed President James Bullard, who is often “seen as a bellwether” and whose views “often reflect the swing in the balance of risks in the economy,” says declining inflation expectations may require delaying the end of QE.

 

His “pep talk” appears to have done the trick: equity markets around the world are rebounding (including European equities and oil).  And here’s something to consider: “whether he tried to or not James Bullard has in effect signalled to traders that the FOMC is committed to jawboning the equity market anytime stocks get down 9% or more.”  Meanwhile, here’s what journalists like to say when they don’t know why the stock market is falling: “the reliance on the ‘profit taking’ crutch reflects a broader problem…an urge by commentators to explain every movement in the financial markets, even ones whose cause is unknown.”  Also, “when stocks go back up…you can credit ‘bargain hunting.’”  Which makes this (alt) right on cue: “buying the dip is alive and well on Wall Street, as investors scour global markets for cheap stocks from the energy and technology sectors to raw materials.”  That being said, expectations are low on post-Alibaba Wall Street: “bankers across Wall Street say that deals on the verge of being announced are suddenly delayed.  I.P.O.s set for this week and next are postponed indefinitely.  And the confidence that had fueled record levels of deal-making is nowhere to be found.”  However, “if stock prices fall precipitously and remain low, some companies may go after targets that suddenly seem affordable.”

 

Meanwhile, it may be useful to keep these charts in mind when the next correction hits.  That being said, serious crashes in the stock market may be inevitable but are not all that likely: over any 100 year period, we can reasonably expect two single day drops of 20% and 61 daily drops of at least 5%.  Also, the recent volatility is a helpful reminder of the equity risk premium.  Meanwhile, recent market turbulence isn’t throwing Richard Fisher off course: “‘a market correction doesn’t mean the economy is in trouble…it’s way too premature to talk about another [round of bond buying] because the market is actually doing the work’ on its own, he said.”