Stocks face risk of steep losses

After the market turmoil last week, there could be more to come.

Global stocks fell last week, with the MSCI All-Country World Index falling 5.4 percent. Even the usually-resilient United States stock market was not spared, with the Standard & Poor's 500 Index falling 5.8 percent.

This week has started off no better. China, which triggered off the market turmoil by devaluing the renminbi on 11 August, is rocking markets again as the Shanghai Composite Index plunged 8.5 percent on Monday, the most since 2007 and erasing its gains this year.

Indeed, some analysts were expecting more declines even before trading started this week.

In a telephone interview with Bloomberg on Sunday, Doug Ramsey, chief investment officer of Leuthold Weeden Capital Management LLC, said that losses in the S&P 500 could reach 20 percent.

“It’s going to be pretty deep,” Ramsey said.

While the recent maket declines had been triggered by China's currency devaluation, Ramsey had already turned cautious in late 2014 as market breadth weakened and US stocks in October suffered what was at the time the worst rout since 2011. He turned all-out bearish at the start of August after the S&P 500 hit a record high in May but gauges of breadth, transportation stocks, utilities and corporate bonds failed to keep up with it.

John Hussman sees even deeper losses in store for the US stock market. In his latest commentary, he said that “we fully expect the S&P 500 to decline by 40-55% over the completion of the current market cycle”.

While Hussman sees market overvaluation as the primary driver of the extent of the losses over the long term, he, like Ramsey, sees the on-going weakness in market internals as a sign of vulnerability to sharp corrections.

In addition, Hussman noted that on Friday, both the Dow Jones Industrials and Dow Jones Transports jointly broke the initial correction lows that followed their joint bull market highs. According to his interpretation of Dow Theory, this means that “the major trend has turned negative”.

Hussman concluded: “Last week's market loss was initial and quite contained from the standpoint of current valuations. My view is that under the market conditions we presently observe, investors face the continued potential for steep, vertical losses.”