Speculators are going to have a Field Day Shorting Stocks on the Downturn

If we look at the current state of the global markets, there is reason to be deeply concerned – although you wouldn’t think so judging by the performance of Wall Street since the 2009 global financial crisis. However, the synergistic functioning of the global economy points to an inescapable reality: every component affects and is affected in turn by every other component. This is to say that what happens in China is not limited to the Asia/Pacific region; when China sneezes the rest of the world catches a cold. The Chinese economic slowdown has nothing to do with speculative sentiment; it is rooted in reality. The numbers speak for themselves:

• Imports year-on-year were last recorded at -20.4% in September
• Exports year-on-year were last recorded at -3.7% in September
• PPI for September was -5.9% year-on-year
• The Caixin manufacturing PMI for September was recorded at 48.3 in September
• The Caixin general services PMI for September was recorded at 50.5 in September

While some of the metrics from China such as the Services PMI are above 50, the trend for manufacturing and production is bearish. This is evident in a wide range of economic data such as declining production figures, declining GDP to 6.9%, and others. The contractions have severely impacted on the demand from emerging market countries especially in mining and energy commodities. That the Fed omitted any mention of the importance of China and emerging markets in its recent statement does not downplay the importance of these components of the global economy. A Fed rate hike typically boosts demand for the dollar and weakens emerging market currencies. But the effect on equities is less clear and more subdued. Since equities markets typically have time to factor in the effect of a rate hike, there is no sudden capital flight from equities as one might expect. Nonetheless, the correlation between interest rates and equities demand is not as clear-cut.

What can we expect in the upcoming week?

The S&P 500 index recently enjoyed a fantastic week, and ended October really well. However, mining and energy stocks are about to unload their recent performance for the quarter on the market and analysts are expecting anything but positive sentiment. In fact, the bears are out in full force and it is likely that sharp contractions are going to take place across the board. Stocks are currently overvalued – that much is evident to most market participants. But there are several other factors to consider in determining whether we are on course for a stock market correction in the near future:

• The number of companies listing on the stock market during any particular year or cycle is an important barometer of market sentiment. The more bullish a market is, the more companies are likely to list in expectation of benefiting from that sentiment. We have seen an incredible number of IPOs listed in 2015, so this is definitely an issue to consider.
• Another measure that gains considerable attention is the fear index – VIX level. The higher a market or an index climbs, the further it has to fall. This lends itself to an increasing fear index. When speculators tend to drive market sentiment in a bearish direction, the possibility of a stock market crash or correction increases. Right now we are seeing higher levels of market anxiety with fears of a China meltdown, emerging markets meltdown, and strong dollar driving sentiment.
• Stocks that rise too quickly are indeed a worrying phenomenon. Investors may be rubbing their hands in glee when stock prices surge, but this also means that they may be burning red hot, and due for a correction.
• One of the most important indicators of future market direction is the level of margin debt in the stock markets. We know for a fact that both Wall Street and Shanghai have made it possible for investors to leverage their positions to the max with access to cheap capital for investment purposes. This is all good and well until greed kicks in in mass selloffs result in stocks plummeting. The correlation between margin debt and stock market crashes is unmistakable, and we are at such a juncture even now.

Of course, there are a multitude of factors that one could take into consideration when attempting to understand whether we are near such a point. For now, we can expect Wall Street to remain steady, as China and the Eurozone are attempting to rectify weakness in their respective economies. A Fed rate hike will impact on the US economy long-term, so short-term corrections are unlikely.

Author Bio: Brett Chatz is a graduate of the University of South Africa, and holds a Bachelor of Commerce degree, with Economics and Strategic management as his major subjects. Nowadays Brett contributes from his vast expertise for the globally renowned spread betting company –InterTrader.