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U.S. stocks last week suffered their largest weekly drop in two years. But some investors worry that falling prices for things like oil futures, gold and bitcoin are offering a more ominous signal that could presage deeper declines.
The broad selloff that featured Friday’s 666-point tumble in the Dow Industrials marked a sharp reversal from the broad-based advance of the past year. Many stock-market indexes have hit fresh records or recent highs. The Dow is still up 27% over the past year, while emerging-market currencies, high-yield bond prices and commodities like copper and gold have likewise risen.
Signs that global growth is picking up while interest rates remain below historical norms has helped propel a broad gains in so-called risky assets. That widespread rally resulted in the average correlation between oil, stocks, bond yields and the euro reaching its highest level in 5½ years, a
Even before Friday’s stock rout, many global investors had grown uneasy about various assets moving in lockstep—especially because trading in many of these markets isn’t typically tied to share prices. Such closely correlated movements are often associated with turning points in the markets.
“The market…had lost respect for the downside,” said Christopher Stanton, chief investment officer of Sunrise Capital LLC. “The idea was that markets could just grind higher.”
A sharp rise across asset classes can lead to an increase in leverage, or the use of borrowed money, before a turn in sentiment prompts a decline in prices that spurs forced selling as borrowers scramble to repay obligations.
That has some investors worried that even if some sort of market correction is inevitable, the number of markets moving in tandem raises the prospect of a more severe selloff than what the still-positive fundamentals would warrant.
“You’re seeing exacerbated moves simply because of crowded positioning,” said Michael Hans, chief investment officer of Clarfeld Financial Advisors.
In some ways, the selling Friday bore a superficial likeness to the sharp declines that rattled markets in early 2016, in which the Dow, oil prices and Treasury yields all slumped before bottoming out Feb. 11. That was the last time the Dow suffered a so-called correction, typically defined as a decline of 10% or more from a recent peak.
Rising U.S. wages may have served as the proximate cause of the Friday tumble. Fears that rising inflation could prompt central banks to tighten monetary policy faster than expected were a problem last week, even though inflation remains at low levels. Bond yields on 10-year Treasury notes closed at 2.852%, the highest close in four years, after U.S. employment data showed wages notching their biggest increase since 2009.
“Inflation is unfortunately something that is very, very broad based and literally hits everything,” said Torsten Slok, chief international economist at Deutsche Bank.
The 2016 selloff, which dropped the S&P 500 index by 10% and sent U.S. oil prices to their lowest level in more than a decade at nearly $26 a barrel, was powerful but short-lived. Stocks and other assets went on to resume a rally that carried stocks to multiple records, dropped bond yields below 1.5% and shook commodities out of their slump, pushing oil prices back above $60.
Some investors anticipate a similar pattern now. Risky assets may fall further before stabilizing, but most of the rally’s foundation remains intact. Global economic growth looks stronger than it has been in years.
U.S. corporate earnings continue to rise. With nearly half the S&P 500 companies have reported fourth-quarter results, more than 80% of them have beaten analyst revenue expectations, the highest percentage since at least the third quarter of 2008 when FactSet started tracking the metric. The new tax law is expected to boost profits in the quarters ahead.
Many investors had been hoping for a shakeout that would bring down sky-high valuations.
But others are less sanguine, especially after a volatile period for much of the week intensified in a powerful selloff on Friday that wiped out much of January’s big gains. The S&P 500 closed the week down 3.9% as the Dow Jones Industrial Average lost nearly 1,100 points, while U.S. crude and gold also declined. The Stoxx Europe 600 had its worst week in nearly two years, and emerging-markets assets also fell.
“I don’t like it,” said Mr. Stanton. “I think we’re going to see more pressure.”
Before last week, the S&P 500 was up 19% and the MSCI All-Country World Index ex-U.S. was up 18% from the start of July. The MSCI Emerging Markets Index was up 26%, and major stock indexes around the world were either at or near all-time highs following one of the broadest January stock-market rallies on record.
Some investors think higher interest rates will upend recent correlations, allowing relatively cheap assets to outperform. Oil is still off 55% from its 2008 all-time highs, while gold and copper are about 30% off their records from 2011.
Volatility also vanished after the 2016 rout. The Cboe Volatility Index, known as Wall Street’s “fear” gauge, climbed more than 50% last week to its highest level since the 2016 U.S. presidential election.
“I do think we should be prepared for volatility,” Mr. Hans said. “This may be the start of it.”