Several things have to happen to set the stage for a summer stock market correction, warned Deutsche Bank strategist Henry Allen.
The analysis: To achieve a more pronounced stock sell-off, Allen said, past experience has shown that at least one of the following factors would be needed:
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A sustained oil shock (or at least valued as such).
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Data that is clearly in contractive territory.
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An aggressive adjustment by the central bank to deal with the resulting inflation.
“So far, it’s hard to argue that we have any of this,” Allen said. “Closest is the point about ‘sustained’ oil shock, as markets are increasingly pricing in a longer period of elevated oil prices. But even there, the six-month Brent future is still just above $90 a barrel, and declining energy intensity means that a given level of oil prices doesn’t create the economic shock it used to. So unless we see a clear change in these fundamentals, then the resilience of risk assets is not particularly notable, but “is in line with the historical record of recent decades.”
Markets at a glance: The stock market has faced notable downward pressure over the past two weeks as the lingering conflict in Iran has triggered widespread inflation anxiety.
The main concern for investors is rising energy costs, with Brent crude oil rising towards $110 a barrel amid continued supply disruptions around the Strait of Hormuz. That will keep gas prices elevated during the Memorial Day travel weekend and hamper consumers’ spending plans.
Read more: What a prolonged war with Iran could mean for gas prices
This commodity rally has actively spread to fixed income markets, pushing the US 10-year Treasury yield (^TNX) to a new 12-month high of 4.61% as bond selling spread to fixed income markets, pushing the US 10-year Treasury yield (^TNX) to a new 12-month high of 4.61% as bonds sold off amid rising fears of interest rates.
Rising yields have dampened Wall Street’s enthusiasm because higher borrowing costs compress corporate profit margins and make safer debt instruments look very attractive compared to stocks.
Consequently, the combination of sticky consumer price data and macroeconomic uncertainty has led to intense profit-taking in the mega-cap technology and semiconductor sectors. Case in point: Shares of popular memory chip stocks Sandisk (SNDK) and Micron (MU) are each down 14% over the past five sessions. Shares of AI chip player Advanced Micro Devices (AMD) fell 9% during this same period.
The final result: Deutsche Bank’s Allen makes some important points here, but it’s worth keeping one thing in mind: markets will begin to price in the factors he mentions before they actually happen.