Correction on the stock market. Graphic: Greatkim – Freepik.com
Last week, the US benchmark index S&P 500 fell out of its uptrend channel that has been in place since the end of October 2023. Starting from its record high on July 16 at 5,669.67 points, the index fell by almost 10%. A correction of around 10% is absolutely appropriate for such dynamic rallies as we have seen since the end of October 2023. But the recent correction in the stock markets does not seem to be a normal correction, because at the same time we are seeing a steepening of the yield curve, which is generally considered a signal of an impending recession.
The 2-year/10-year Treasury yield curve has steepened in recent weeks after weaker U.S. economic data signaled a slowdown in the U.S. economy. This development is typical when the economy is heading for a downturn.
S&P 500: Signal for a recession
When the S&P 500 falls while the yield curve steepens, it is often a sign that financial markets are beginning to price in a recession. That is exactly what we have seen in recent weeks. The S&P 500 fell by around 10% while the yield curve steepened. The chart of TradingView shows the recent price collapse of the S&P 500 – the important 200-day line was defended.
S&P 500 correction: US leading index falls out of its uptrend
Concerns about a recession in the US and the collapse of the carry trade were responsible for the collapse in the US stock markets. However, fears of a recession have since subsided. Slightly better economic data at the end of last week and the prospect of several interest rate cuts by the Fed give hope for a soft landing for the US economy.
According to the creators of Game of Trades, however, there are good reasons to be bearish on the stock markets. The US benchmark index S&P 500 could face a much larger correction than the collapse a week ago. One reason for this is the extremely high valuations, which continue to rise due to falling corporate profits and a potential economic downturn. Shiller PE Ratio Despite the slump, it is still trading above the 30 mark, which is significantly above the long-term average.
Stock markets on the verge of a new rally?
But there are also indicators that speak against a further sell-off of stocks: such as the VIX, the volatility on the S&P 500. The fear barometer VIX exploded last Monday, jumping to a value of 45. Such strong breakouts often mark the bottom of a correction and herald the beginning of a new rally that can lead to new all-time highs on the stock markets.
The Fed could also provide a boost if it begins the easing cycle in September at the latest. The key question as to whether the stock markets are facing a major correction or are about to begin the next rally is: is the recession coming or not? Historically, stock markets fall when the Fed has to cut interest rates due to an economic downturn. However, if it cuts interest rates while the economy remains robust, the stock market rally usually continues.
In the following video, the makers of Game of Trades show the most important indicators that speak for or against a major correction on the stock markets and then draw up a balance.
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