This is just another 5% to 7% pullback, like many we've seen over the past three years. The recent decline may be the next pullbacThe good news is that the S&P 500 is already down almost 5% from the peak on July 19.
A 5% to 7% pullback is the modern equivalent of the 10% correction of prior market cycles given the elongated and smoother business and Federal cycles.
Second, the temporary unwinding of the yen carry trade is nearly over. When the yen rises sharply against the dollar and the prices of riskier bonds fall, huge losses can result from carry trades.
In 1998, this was a major reason for the collapse of the infamous hedge fund Long Term Capital Management. Carry trades are a major source of cheap funding and global liquidity. A sudden unwinding in the carry trade creates a feedback loop that augments existing credit concerns and often results in negative--but temporary--movements in equity markets.
Third, profit worries are overblown. Earnings growth has slowed into the single digits; however, growth is poised to rebound. Leading indicators of profits have turned up, including the Index of Leading Economic Indicators from the Conference Board, the Institute of Supply Management's Purchasing Managers Index, and the Federal Reserves measure of Capacity Utilization. At the same time, valuations have started to rebound, but remain near the low end of the range of the past 10 years.
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