US stocks near correction territory; is it time to turn bullish?

Equity markets sold off aggressively on Wednesday dragging the S&P 500 2.4% lower for the day and the index is now down nearly 9% from its record high set at the start of the month. We are almost in correction territory for the world’s most followed stock market, which is defined as a 10% fall from its latest peak. Meanwhile the tech heavy Nasdaq composite is already in one, having lost 12% in value from its August highs.

Investors who missed the six-month rally since March may find it compelling to dive in now as many stocks have corrected their excessive valuations, especially on the Tech front. The likes of Tesla, Apple and Amazon have been dragged 15% to 30% lower in a matter of three weeks. The selloff however has been broader this time, with the energy sector back to the April levels when Oil futures contracts fell into negative territory for the first time ever.

If the latest selloff is just about the removal of froth and a healthy correction, it may indicate we are near a bottom and it’s time to reaccumulate stocks. This approach would be based on the notion that the US and the global economy will continue heading in the right direction towards a full recovery. And with central banks across the globe remaining extremely generous with their policies, we should not worry about some bumps along the road.

However, the risks of a stalling recovery are growing as spikes in Covid-19 cases surge across Europe and expectations are for similar trends in the US if no action is taken. The virus continues to be winning at this stage and there are no clear answers as to when a vaccine will be delivered.

Fed Chair Jerome Powell and some of his colleagues are pressing Congress for more fiscal stimulus, in a sign that monetary policy cannot do much more to support the economy.  But heading into the Presidential election and given how divided Congress is, the chances of delivering a stimulus package soon is fading. Add to this President Trump’s refusal to commit to a peaceful handover of power if he loses the election on 3 November and it all makes great ingredients for extreme uncertainty and volatility in asset prices.

Overall, we continue to see the risks skewed to the downside and more volatility in the next two months, so despite the recent correction in prices, it does not look tempting to turn overly bullish. Unless Congress surprises us with another convincing round of fiscal stimulus, it will be wise to wait for more attractive valuations.

Gold is another asset that has been sold aggressively over the past four days. This is mainly due to the stronger Dollar, a slight increase in real yields and a break below the $1,900 support level. Expect Gold to gain some traction here as its one of the few assets available to hedge against future expected volatility and the prolonged period of low interest rates.