Stocks under threat in second half of 2018

Markets fell last week, with both the S&P 500 and the STOXX Europe 600 falling 1.3 percent.

Both indices saw gains for the second quarter though. The S&P 500 rose 2.9 percent while the STOXX Europe 600 rose 2.4 percent.

Last quarter's gain helped the S&P 500 finish the first half of 2018 up 1.7 percent but the STOXX Europe 600 still finished the first half with a decline of 2.4 percent.

However, the S&P 500 may not remain unscathed in the second half of 2018.

Craig Johnson, chief market technician at Piper Jaffray, told CNBC last week that as the Federal Reserve tightens monetary policy, the spread between the 10- and 2-year Treasury bond yields is likely to continue flattening.

Johnson said that as the curve flattens and possibly inverts, economic growth could slow and equities could be hit, with the financials sector being especially affected.

Meanwhile, corporate credit markets are already showing signs of stress.

According to Bank of America Merrill Lynch, high grade bond funds have posted outflows for five weeks in a row, and high yield funds have posted outflows for 32 consecutive weeks.

“The credit cycle is past its peak, and credit tends to lead equities in signalling a maturing cycle,” wrote TS Lombard analysts in a note earlier this month.

Indeed, stocks already look vulnerable, according to John Hussman, president of Hussman Investment Trust.

Hussman noted that “present market conditions reflect not only extreme valuations” but also “deterioration in market internals”. He suggested that “investors should seriously consider the prospect of a market decline on the order of -65% from the recent market highs”.