24 February 2019
Rate hikes are unlikely to pose too much threat to the stock market, given that the current rates remain extremely low. Photo: Reuters
Rate hikes are unlikely to pose too much threat to the stock market, given that the current rates remain extremely low. Photo: Reuters

Is the equity bull market over?

The US stock market has suffered a sudden crash over the last few days. The biggest question now is whether the bull market cycle has already come to an end.

The Dow Jones Industrial Average has slumped over 10 percent during last six trading days from a peak of 26,616 points. The CBOE Volatility Index (VIX) has spiked to over 30 from a low of 9.15 early this year, the highest level since 2015.

There are mixed views as to what triggered the recent market collapse. Some say rising inflation has stoked concerns that Fed may accelerate the pace of rate hikes. Others blame spiking US Treasury yields.

There is also talk that machine trades made the selling more dramatic, while others maintain that the  US market has already reached overbought territory and therefore, a correction has been long overdue.

Although the latest US wages data was a bit of a shock to the market, that alone does not necessarily mean the Fed will accelerate raising rates in the short term.

St. Louis Federal Reserve president James Bullard on Tuesday said that the strong US labor market does not mean that higher inflation is just around the corner.

A more reasonable explanation is that the US market rally has been extremely over-stretched, and the RSI indicator of S&P 500 has already hit an all-time high of 90.5. As such, a correction is long overdue. The market selloff could also have been amplified by machine trading and rising inflation concerns.

Now, does that mean the end of the equity bull cycle? I don’t think so.

I still believe that the Hang Seng Index would hit 36,000 points at least within this year, and even test a new high of 39,000 points.

Historically, a rate hike is usually not the reason for the reversal of an equity uptrend.

Quite the opposite, equities typically trend upward in a rate rising cycle. But when interest rates are falling, equities are usually weak.

This is not difficult to understand. Interest rate cuts usually come at a time when the economy is not doing well and corporate earnings are lackluster, thus the need for stimulus.

I believe rate hikes won’t pose too much threat to the stock market, given that the current rates remain extremely low.

Even if the Fed raises rates four times or even more this year, that won’t exert excessive pressure on the economy or on equities.

Second, the 10-year US Treasury yield has already broken out of the three-decade range and has kept rising. Higher interest rates would even push the yield further up this year.

If so, investors are likely to rotate to equities away from debt this year, given that the outlook for corporate earnings looks encouraging. That would be a major support for equities.

Historical data attests to the point that rising bond yields usually correspond with rising equities, with this happening 13 out of 16 times since 1930 when bond yields showed year-on-year rise.

Inflation may pick up modestly this year as economic expansion extends into the third year. But inflation is unlikely to spin out of control. As long as this is the case, there is no reason to be overly bearish on equities.

This article appeared in the Hong Kong Economic Journal on Feb 8

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist

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