Market declined more than 200 points after Fed’s announcement regarding potential QE tapering. This announcement accompanies the fact that Chairman Bernanke will be stepping down soon. Both of these developments created uncertainty among investors, and gave them a reason to sell out of their positions. An interesting observation regarding today’s action is that today all asset classes ranging from stock to commodities went down. In the last few years, days like today where all assets went down together have been considered deflationary.
One can say similar things about today's market action i.e. Fed’s tapering could bring back deflationary pressure and will force a market sell-off. However, previously when we had such deflation related sell-offs, bond prices went up as part of a risk-off trade. But today, bond prices also declined along with the rest of the market.
On one hand, this behavior makes sense because Fed’s departure as a ginormous bond purchaser would reduce bond demand. But on the other hand, this also means that U.S. bonds are no longer attractive in the global market. It was just the Fed that was fueling the bond rally over the past few years. This would also hint towards a weakening U.S. economy and potential Europe like scenario in the United States.
In Europe last year, both stock and Bonds went down as the credit crises spread from one nation to the other. We have already discussed this scenario in our analysis over the past few weeks. Keeping this in mind, let’s do a scientific analysis to understand the future of U.S. economy:
If the U.S. market keeps acting weak over the next few weeks and the bond/commodity prices keep on declining then it would suggest that
- We are heading towards deflation è Weak stocks and commodities
- Bonds are declining because Bond Bull market has ended and confidence in the U.S. economy has begun to erode.
On this blog we have already discussed (here) a possibility of a sharp decline in the U.S. markets based on performance of emerging markets. Emerging markets have been declining for the past several weeks. In fact they are in 3 of 3 wave decline, which could result in significantly lower levels. Furthermore, we have already discussed Head & Shoulders patterns being completed in the Bond and Emerging Markets.
Head and Shoulders mean that these markets have topped and we could see further decline. Therefore, at this point in time, one should be careful about the market (stocks and bonds) and its downside potential. Downside surprises can be expected. Emerging Market and U.S. markets topped out at the weekly IPM Model turn date (sent to subscribers). IPM Model will be used to identify upcoming market turns and will be emailed to subscribers on a regular basis.
In the next update, we will be discussing Elliott Wave analysis of the U.S. markets.