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The dramatic tumble on Wall Street at the beginning of February left many investors the world over jittery.
But market experts agree that, in general, it was about time for a strong correction.
Notably, many experts have recommended investors to be on the lookout for buy opportunities during the correction.
Indicative of exactly how wild things got on Wall Street, the largest gap between the Standard & Poor’s 500 Index and its 200-day exponential moving average since the current bull market kicked off on Wall Street nine years ago, occurred this past month.
The index had, for example, shot up by about 100 points within the first 10 trading days of 2018, and when the first pause set in on 26 January, it was 165 points higher.
This confirms that Wall Street, the world’s leading market, is showing clear signs that it’s in the so-called third phase of the market cycle. (See my previous article here.)
According to the Dow theory of market movements, which is widely followed by investors across the globe, a share market moves in three phases in the long term.
The first bull phase begins when prices move sideways and then gradually upwards after the bear has created a recovery in values. Uncertainty is the catchword.
After quite some time, during which informed investors buy bargains, the second phase of the new bull market is ushered in: Optimism increases, which leads to firming prices.
Good value is generally available, but big bargains – as we had in the first phase – are scarcer.
Then we get the third phase, which turns into wild speculation with prices being pushed up to new highs by uninformed investors and have little to do with underlying values.
It’s the so-called fools’ market in action. One fool sells at a higher price to the next fool, who in turn sells to the next one, until – theoretically – the last fool has bought and then the drama begins with tumbling prices.
If we look at how strongly the market has run this year – before the current correction – then there’s little doubt that more and more new amateurs have begun playing the market in the hope of making a quick buck.
A question that is being asked is how long the third phase will last in light of the current strength of the US economy.
Some technical analysts point out that in the past, the market often tumbled drastically during the third phase, notwithstanding what’s happening in the economy, mainly because it has simply overheated.
It has always happened that overheated markets will sooner or later be followed by a bear market to allow values to recover.
An extended bull market as we are currently experiencing is highly exceptional. Since the S&P 500’s low in February 2009, this index has increased by about 320%.
This leaves a lot of room for correction before calling it a bear market. Usually, the arrival of a bear will be met with surprise and even incredulity by many amateur market players.
On the other hand, there are those – mainly investors who follow fundamentals – who believe that the Trump boom could continue for some time given the good news about the economy.
US President Donald Trump does not hesitate to take the credit for this, although he inherited a sound economy from Barack Obama.
There is much to crow about: Jobs are plentiful – the unemployment rate of just over 4% is the lowest in years – and, importantly, business confidence is high and consumers optimistic.
The lowering of tax and deregulation that Trump promised will give it a further boost.
At the same time, inflation is not currently a problem while wages are increasing in real terms.
Prosperity in the US is supported by an increase in international growth. Europe’s massive economy is expected to grow by about 2.5% this year, while Asian countries are generally also faring well.
So it’s a synchronised global growth that serves as a background to companies’ increasing profit prospects.
It’s also noteworthy that fixed capital investment is increasing globally. South Africa is unfortunately an exception – too little of the money flows this way, while local companies are reticent to invest, mainly due to political uncertainty.
It’s interesting that although the global upswing is still at an early stage, the US cycle has already reached maturity, which usually goes hand in hand with interest rate increases to counter overheating, as well as inflation fears and being vulnerable to unexpected shocks.
It’s worth noting that the gap between long- and short-term interest rates has narrowed.
Economists point out that in the past this usually happened before a major setback or even a recession. However, at the moment there is no sign of a decrease in the growth of the world’s largest economy.
But even if the economy is flourishing, it’s impossible for company profits to keep up with the rapid rise in share prices on Wall Street in recent times.
The widening gap between profits and share prices is typical of a third phase and is a precursor to a bear market to correct excessive prices.
Lucas de Lange is a former editor of finweek and the author of two books on investment.
This article originally appeared in the 15 February edition of finweek. Buy and download the magazine here.
