Cracks are showing in what has been a virtually non-stop US equity rally after a rapid escalation of tension between North Korea and the United States this week.
Market analysts expect that the pullback in stocks due to the increasingly aggressive tone in exchanges between Washington and Pyongyang will continue, although investors hope that the selling will not escalate to a correction – a decline of 10% or more.
The benchmark S&P 500 index tumbled more than 1% on Thursday, only the third time this year it has fallen that much, while the Nasdaq shed more than 2%.
“Markets are looking for any reason at all for a reset. That reset is being triggered by North Korea geopolitical concern and stretched valuations,” said Peter Kenny, senior market strategist at Global Markets Advisory Group in New York. “I do think we could see markets pull back between 1 and 5%.”
The S&P is trading near its most expensive valuation level since 2004, as measured by the price-to-12-month forward earnings ratio.
US stocks have risen week after week this year – with the S&P up more than 9% – in extremely low volatility, as strong corporate earnings and an improving global economy offset disappointment that US President Donald Trump’s promises to lower corporate taxes and implement a massive infrastructure spending have so far failed to see the light of day.
Until this week, the equity market had managed to shake off negative news, including previous sabre-rattling over North Korea and failures in Washington to pass high-profile bills, such as repealing and replacing Obamacare.
But although US equities on Wednesday managed to close only slightly down even after Trump’s warning that “fire and fury” would rain on North Korea, on Thursday the chickens came home to roost on Wall Street.
More than 430 stocks from all US exchanges hit their lowest levels in 52 weeks or more on Thursday, the most for any session since mid-November right after Trump was elected.
The average for new 52-week lows this year is about 230 per day.
“The easy money has already been made,” said Joel Kulina, senior vice president of institutional cash equities at Wedbush Securities in New York. “I’m looking selectively at the pullbacks, but my gut is that we could be in for a bumpy ride for the next couple of months or so.”
Many market participants have been calling for a significant decline on the S&P 500.
“A pullback is good so the market doesn’t get unidirectional. This is a normal fluctuation, it just seems so odd because we have hardly had any volatility,” said Jim Paulsen, chief investment strategist at The Leuthold Group in Minneapolis.
If the decline continues, Paulsen said, it will be “a good buying opportunity. I’d look into energy, materials, industrials, tech and financials. I think before the end of the year the market goes to new highs and (Treasury) yields go higher.”
The benchmark US yield on Thursday was just above 2.2%, at its lowest level since late June, as investors bought up Treasuries, a classic safe harbour.
Yields on bonds move inversely to their price.
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