Key points

• There is a chance of a 10% correction on Wall St, led down by the Dow Jones Industrial Average.
• Expected timing is for September, which is a seasonally weak period in markets.
• If there is a 10% correction on Wall St, the ASX200 should fall significantly less because we have already experienced a correction.

There’s certainly no lack of volatility in global and domestic equity markets at the moment and I expect that to continue into the Fed’s first interest rate rise in nine years in September. While the Fed’s likely rate rise is well telegraphed, the market reaction in the US dollar, bonds and equities is unlikely to be subdued. It will be a buy, sell and trade the fact across asset classes.

Pressing pause

As regular readers know, I generally have a bullish disposure. That has served me well over the years. However, right at the moment I am unsure of what comes next and would describe myself more as “neutral”, particularly on US equities where the broader price action looks a little tired.

In terms of US equities the key problem is “breadth deteriorating” and “momentum reversing” in a number of key index weight stocks, most noteably Apple, which recently broke back down through its 200-day moving average. The one-year Apple chart is below.

While only a technical development, the reversal in Apple momentum, when combined with the falls in heavyweight oil stocks and some IT stocks, has also seen the Dow Jones Industrial Average break its 200-day moving average.

Dow stocks have been feeling the most pressure, in earnings terms, from the resurgent US dollar. It’s also worth remembering that the Dow doesn’t include Google, Amazon, Facebook, Netflicks or Amgen that have helped drive outperformance of the S&P500 and Nasdaq 100 this year.

The Dow’s EPS growth has been lacking and next quarter will see another fall in earnings, albeit just -2%. In my experience it remains difficult for an index to advance if earnings are going backwards. It’s worth noting the Dow component Disney downgrading its outlook last night and its subsequent 9% fall.

The five-year chart below suggests to me there is near-term downside risk n the Dow Jones Industrial Average on a purely technical basis. The 50, 100 and 200-day moving averages have broken and it may suggest the Dow is headed to the next support level around 16,000.

Possible US correction

What I am trying to tell you is I think there is a chance of a -10% correction on Wall St, led down by the Dow Jones Industrial Average. The Dow Jones Transportation Average (Dow Transports) has recently experienced a correction DESPITE the oil price making new lows. People who follow “Dow Theory” would subscribe to the view that the Dow itself will follow the Dow Transportation Average’s correction.

It’s fair to say no equity market has had central bank support for longer, or in larger scale, than US equities – $4.5 trillion on QE, forcing investors from cash and fixed interest into equities, and 0% cash rates for seven years.

A previously devalued US dollar drove converted US equities EPS growth, while buybacks went to a scale never before seen, generating near to 50% of total EPS growth in the last 5 years. I suspect I am NOT ALONE wondering how US equities will perform with a higher US dollar and less support from the Federal Reserve. In a world dominated by central banks, my strategy remains to place my biggest long bets where there is the BIGGEST central bank support (Europe, Japan, Australia for income).

Vice versa also applies and that is why my fund has very limited US equity holdings at this point and is running some tactical index futures shorts. I think patience will be rewarded here in the next few months and I will be looking to take advantage of a -10% pullback on Wall St if it comes.

Timing is everything

The timing I suspect will be September, which is a seasonally weak period in markets. This year September will see the first Fed rate rise, and when you overlay seasonality and weak technical, you can see how it could turn into a -10% correction.

I suspect many investors are saying “so what” and that’s fair enough, but if I am right and Wall St corrects -10% in September then it will coincide with the period when Australian equities are ex final dividends and the S&P/ASX 200 loses physical dividend support.

What tends to happen is the 45 days leading up to the final dividend period in August is that the ASX200 does well, then in September the market struggles ex-dividend and comes under some DRP (dividend reinvestment plan) pressure. This year’s DRP pressure could be pretty big, led by the CBA DRP.

If this all plays out, I would expect the ASX200 ex-dividend to trade down to the level of 5400. The chart below is of the September ASX200 SPI Futures, which are priced effectively ex-dividend. They suggest we may have seen the best of the “cum-dividend” full year results rally and a US led pullback is pending.

Some buffer

Don’t get me wrong: if there is a 10% correction on Wall St there’s no doubt in my mind the ASX200 would fall significantly less because we have already experienced a correction. It would be another buying opportunity in the right Australian (and global) equities, but one worth waiting for in my opinion.

They say patience is a virtue. I believe over the next few months patience will reward investors as we head into the first Fed rate rise in nine years. Just keep a little firepower dry – a better buying opportunity may well present itself in the months ahead.

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