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A sick market is set to be tested further

·Michael Santoli

When the patient isn’t improving fast and the doctors are stumped, they order more tests.

Even after bouncing hard off last week’s lows, the stock market has appeared unwell, with jumpy vital signs and acute sensitivity to new stimuli.

The Dow Jones Industrial Average fell more than 300 points at the start of trading Tuesday to below 16,200, following following sharp declines overseas. Stocks in Asia and Europe falling more than 2% overnight. 

The latest setback in global markets following a weak Chinese manufacturing report - with stocks in Asia and Europe losing more than 2% overnight - will surely stir up calls that the S&P 500 (^GSPC) needs to “retest” the recent lows, which sit some 5% below Monday’s closing quote.

This is all from the standard the standard trading-desk playbook, which holds that true “V” bottoms are rare. Even though we pretty much got a flawless “V” last October, it’s more common to knock around the vicinity of market lows for a while to see if the lower prices attract strong-handed buyers – or not.

It’s easy to get too caught up in the technical trader tactics at times when market prices start moving faster than perceived fundamentals. But the bottom line is, the market has to prove that it has priced in this whole China slowdown/emerging-market spillover/Federal Reserve coin toss litany of concerns.

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Part of this process involves bullish forecasters rethinking their optimism. This has begun, with Morgan Stanley strategists joining their counterparts at Credit Suisse in reducing targeted upside for the S&P 500. Both firms still see the index returning to the vicinity of its all-time highs between 2100 and 2200, but the moderation of enthusiasm acknowledges how far these targets now appear.

It’s quite possible that the more significant downscaling of expectations occurs with corporate earnings forecasts. As analysts return after Labor Day, it will be time to true up their estimates with the pace of economic activity. That should not be much of a problem for U.S.-based firms, but the global companies are at risk of more cutting and “preannouncements” of curtailed profit outlooks.

No doubt, there’s plenty more at work in this selloff than the mere tweaking of corporate earnings models.

This was a stock market that entered the year not owing investors very much after nearly six years of gains. It wasn’t cheap to start with but held up nicely for months, and now is “catching down” to values that had already been priced into corporate-debt and emerging-market currency prices.

On top of that, some level of anxiety makes complete sense ahead of what could soon be the first start of a Fed tightening cycle in 11 years, after seven years of zero-percent short-term rates.

We all know a small hike from zero makes little difference in the real economy, but who’s willing to bet that other investors are sure to treat it as no big deal?

Oh, and did you hear it’s now September, the worst month on average for stocks? This is contributing to the general reluctance of investors to play the hero and assume we’re all clear for a lasting rebound, even though the real-time record of these seasonal patterns is quite spotty.

Meantime, the frequent reminders that the Chinese government have a loose grip at best on the domestic economy there, have been unable to stem selling in stocks and undertook a clumsy currency devaluation sap confidence in central authorities once considered competent and omnipotent.

And over here, we can’t even manage to open trading in ETFs without a hitch?

Who knows, too, what psychological effect Donald Trump’s surge in the polls is having on broad psychology? The market correction quietly got underway the week of July 20 - the same week Trump's poll support among Republicans broke out above 20% on its way past 30%.

If not simply his hostility to free trade and immigration, then the very fact that the experts in the middle have been so blindsided by his populist upwelling of support is enough to have us all questioning whether those in charge know as much as they were given credit for knowing.

Unsettled, unhealthy markets give rise to musings about a world that can always be portrayed as disordered and risky. But for many investors, all of these anxieties would be eased by a successful retest of the market lows – or, better yet, a refusal by the stock indexes even to get back down there. There won’t be a need to call the lab for the results - they'll be obvious on your screens.

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