The recent stock market correction shaved about $6 trillion off the market capitalization of equities worldwide, and a recent report from Bank of America Merrill Lynch (BAML) outlines six reasons why another plunge of similar magnitude is possible. For investors in U.S. stocks, the impact would be a return of the S&P 500 Index (SPX) to its intraday low on February 9, or 4.7% below its open on March 2, per BAML's calculations.
For the Dow Jones Industrial Average (DJIA), revisiting its February 9 intraday low would be a decline of 4.2% from the March 2 open. Meanwhile, the Investopedia Anxiety Index (IAI) continues to record extremely high levels of concern about the securities markets among our millions of readers worldwide.
Six Negative Forces
In this week's edition of its The Flow Show report, BAML offers these six reasons why the S&P 500 may once again test its recent low on February 9:
- Investor optimism appears to be peaking, given very bullish readings on the firm's Bull & Bear Indicator of investor sentiment. Also, investors have been aggressively buying on the dips, inflows into equities were strong in the most recent week as measured by BAML, and asset allocations are still tilted toward stocks. All these are contrarian indicators.
- Corporate profits also seem to be peaking, given 12-month forward earnings estimates that are "booming." Also, high consumer confidence and low unemployment lead BAML to say "sell hubris & booms."
- Regarding policy, BAML sees "no more stimulus to discount." Rather, the Federal Reserve and other central banks around the world are withdrawing monetary stimulus, hiking interest rates.
- Protectionism is rearing its head, which is a negative for stocks. In fact, BAML says, "stocks down may be necessary to stop escalation of trade war." (For more, see also: Dow Falls 1 Pct as Trade War Fears Hurt Industrials.)
- Tech stocks are not making new highs, credit spreads are not reaching new lows, homebuilders are hitting new lows, and stocks are no longer outperforming government bonds on a global basis.
- Inflation, interest rates, and stock market volatility are all on the upswing. Previous lows hit by all three were critical drivers of the current bull market.
The recent net weekly inflow of $17.7 into equities included $1.3 billion into tech funds, the fourth-highest figure ever, BAML adds. They observe crowded trades (excessive buying) in tech, financials, and emerging market stocks.
Meanwhile, the recent pullback in the Bull & Bear Indicator from 8.1 to 7.6 may be a significant sell signal in itself. The MSCI All-Country World Index (ACWI) fell by a median 3.2% in the next three months, in eight of the last eleven times when the indicator retreated below a value of 8, BAML says.
Trade War Worries
Bank of America Merrill Lynch is not alone in its concerns. The stiff tariffs announced by President Trump on imports of steel and aluminum have led several market strategists to worry about trade wars that could send stocks back down to their February 9 lows, if not even lower, CNBC reports.
"I know of no economist who is on record saying trade tariffs and trade restraints are good for economic growth," as Jack Ablin, chief investment officer at Cresset Wealth Advisors, told CNBC.
Recessions and Valuations
Before the Trump tariffs were announced, billionaire investor Ray Dalio, chair of Bridgewater Associates, indicated his belief that the U.S. economy is likely to be in recession by 2020, per another CNBC report. Others disagree, seeing indications of persistently strong economic growth. Whether or not a recession is looming, historically high stock market valuations continue to be a source of worry, trade wars or not. (For more, see also: Why Big Stock Investors Are Bearish Despite Rally.)