Most of the losses in the stock market on Friday occurred in the first 15 minutes. The financial media are attributing it to renewed fears of Greece exiting the Euro and China clamping down on margin lending. While Greece adds significant uncertainty to the markets, we know the Chinese equity futures crashed after their close on Friday with an announcement from the China Securities and Regulatory Commission. They announced a significant tightening of rules governing margin lending and trading while liberalizing rules on short selling.
It seems over the last year many mom & pop investors have been opening brokerage accounts jumping in on the party with borrowed money (margin) driving the Shanghai index up 100% since last July. All the while, the Chinese economy has been slowing down significantly. The immediate effect of this policy will be a sharp sell off on the Shanghai starting Monday as those buying on margin are forced to sell and short selling should jump. In other words, China decided to pop their bubble before it got larger and could do more damage. We then had a sympathetic bubble sell-off in Europe and the US on Friday. Note: The Shanghai is not part of the TSP I fund.
To offset the impact of their bubble popping and to provide monetary support for the real economy, the PBOC also announced they were lowering the Reserve Requirement Ratio for all banks starting Monday which will flood the banks with addition funds. The monetary easing should be a positive for the international markets, but we could still see the S&P 500 finish its current correction.
The chart below provides the relative performance of the TSP funds since the beginning of the year. The I fund has benefitted from the launch of the European Central Bank’s QE. The TSP C fund has lost ground to the TSP S fund due to the international exposure of its earnings and the impact of the surging dollar. The loss on Friday, while painful in its timing, was within all of the equity funds up-trending price channels. But we do have to be concerned about any emerging catalyst for a larger risk-off market correction.
I would also like my readers to make note of the correlation of the C/S/I equity funds. They move up and down together. Over different time frames they will trend at different rates, but they are highly correlated. You are not diversifying by holding all these funds together, you are averaging gains and losses. If the US stock market enters a bear market, the I fund will also.
When interest rates finally start moving up (if they ever do), then the F Fund will experience losses and typically the stock market struggles in a rising interest rate environment. In this case, cash will be king and the G fund will be the only non-correlated fund.
The dotted green lines provide a reference for the market’s trend since the 2009 market bottom. The dotted red lines represent a short term price channel since early 2014. The index has moved from the top of its long term trend into the lower half of its long term price channel. While the market can bounce on Monday and stay within the green price channel through the end of April, I would be surprised if the S&P 500 can continue this steep climb through the summer with the headwinds it currently facing – monetary tightening, lack of earnings growth, and a slowing economy.
We see the dueling price channels with the recent market action. I also added the 100-day Simple Moving Average (SMA) that has provide recent support – it sits at 2065 at this time. If the market corrects below 2058 (arrow) for the S&P 500 index then we have a lower low after a lower high and this will create some concern. A close below 2040 would create more concern especially since we are in a seasonally strong month for equities.
April is one of the strongest months for the markets and recently most of that strength has come in the last half of the month. Looking at the TSP Smart Investor almanacs, 2005 was the last year the second half of the month was down for the TSP S fund. We will be watching the market action over the next few weeks closely as it will tell us much about this old bull market.