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US Equity Market long term correction expected

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The Conference Board’s Consumer Confidence Index showed an improvement in December after posting a decrease in November.  The index stood at 96.5 up from 92.6 in November and the “Present Situation Index” has also increased to 115.3 in December from 110.9 a month earlier.  This data reveals that consumers are upbeat about the current state of the economy.  However, on an uneasy note the consumers forecast for 2016 remains flat in terms of business conditions and labor market. Still expectations, regarding financial outlook, remains leveraged towards the optimists for now.  The December gains have been largely due to lower inflation, which has bolstered real incomes and prospects for purchase of household durables have improved.  A point of concern is the sudden dip of home sales below the threshold of 5 million at a seasonally adjusted rate of 4.76 million in November, which is a substantial 10.5% drop from a month earlier and starkly below 5.4 million consensus estimate. National Association of Realtors (NAR) blamed sparse inventory affordability issues.

It is rather likely that markets will react uneasily about FED’s more aggressive rate hike forecast for 2016.  Calls of four 0.25% hikes seems implausible as a fast rate hike is tantamount to derailment of economic recovery and consequently stabilization.  Markets have a mind of their own as indicated by the roller coaster ride they took in 2015.  They veered to record highs and then nosedived at the fastest pace over the last four years, and then ended mostly flat during 2015.  Of the things that kept the markets veering has been the rather erratic performance of the economy.  For example, the GDP started sluggishly at 0.6% during the start of the year, depressed by severe winter conditions and then propped up to 3.9% in the following quarter and then slowed down to 2.1% and 2.0% in the subsequent quarters.  In the meantime, Wall Street kept a close eye on Federal Reserve’s policy rate decision.  While the FED meandered on its decision to enact rate hike, the central bank kept looming large over the market as the market correctly purported the idea that a rate hike was a risk to the market.  This eventually turned out to be the case.  Some could think that the market is at a precipice, with the price action of DOW JONES Industrial average operating below the 30-day average.  But there is more to the reading that simply the moving average.  From an Elliottician standpoint the market may also be on a precipice.  For example, the wave pattern has completed its 5 phase progress and now correction is underway.  So in case of protracted cycle of interest rate hike during 2016 stock market may continue to react impulsively post the intermediate term. Dow Jone Industrial Average

Another variable to monitor should be US bond yields.  The changing slope of the yield curve is telling of investors perception on how the economy may perform and is worth its due interpretation.  A negatively sloping yield curve is indicative of a looming recession and this was apparent in June 2007 just prior to the onset of the financial crisis.  What has been witnessed is that many money managers/traders have shown a preponderance to purchase short Markit USterm debt, which has reduced the short term yields viz a viz long term yields.  For example, the two-year note was just trading at 1.095%, the highest since April 2010 and rapid jump from 0.668% at the close of 2014.  However, this scenario can change starkly if the FED is overaggressive on its stance to raise interest rates too quickly and investors become skeptical of short term growth prospects and start investing long term (wealth effect), thus inverting the relationship of yield.  The current Markit U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) has shown signs of stagnation in the aftermath of FED decision to raise interest rates as it reached a level of 51.2 down from 52.8 in November.  Weight should be placed on the cited anecdotal evidence of subdued demand and dampened business confidence amongst clients, as causal factors.  While a reading of above 50 points to an expansion, 51.2 is much lower than the last year’s survey average of 54.2.  Yellen did say in the past that if there is support from data, then rate hike would be “a prudent thing to do” as it would allow FED to move at a “gradual and measured pace”.

Now a “prudent thing to do” would be to place confidence in FED’s decision, and keep an eye out for signs on whether or not the economy is stalling!!

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