What we are seeing is good old profit-taking.
The S&P/TSX composite is down over 200 points, or over 1 per cent. The losses are replicated south of the border, although less severe. The Dow Jones industrial average, the S&P 500 and the Nasdaq Composite are each down approximately 1 per cent.
Tuesday's weakness does not appear to be a sign of an impending market meltdown, but, rather, it reflects prudent profit-taking.
There is not a single factor causing the weakness and weighing markets down. A number of factors are to blame, including weaker-than-expected economic data, the rising U.S. dollar, seasonality and an overbought trade in commodities.
And the commodities market was overheated.
The recent rally in the S&P/TSX composite index has been led by resources and fuelled by spiking prices in oil and gold. The price of oil has rallied over 70 per cent from $26.11 (U.S.) on Feb. 11 to $44.78 on May 2, with the U.S. dollar falling. The price of gold has jumped to nearly $1300 (U.S.) an ounce from under $1100 at the start of the year.
The parabolic moves in commodity prices are unsustainable, and a pause is warranted.
The blistering pace of oil's recent gains has not been driven by a dramatic change in fundamentals.
According to a recent Reuters report, oil production from the Organization of the Petroleum Exporting Countries (OPEC) increased in April, nearing historical highs. For now, it seems that there will be no imminent intervention measures taken in order to curb production, and U.S. inventory levels remain high.
In addition, there was more negative news released overnight from China. The April Caixin Chinese manufacturing purchasing managers' index came in below expectations at 49.4, below the expansionary mark of 50, for the 14th consecutive month.
Meanwhile, in the United Kingdom, manufacturing activity fell into contraction territory, with the April Markit/CIPS purchasing managers index falling below 50, to 49.2, its lowest level since 2012. This has caused global economic growth concerns to resurface.
Turning to seasonality, according to historical data, much of the gains in equity markets are realized early in the year. Research studies have shown that buying at the beginning of November and selling at the end of April has proven to be an effective strategy. This is likely also contributing to selling activity.
We recently passed the halfway mark for this earnings season.
Looking at the S&P 500, while earnings deceleration continues, there is a silver lining. Analysts' estimates appear to be conservative, enabling more companies to beat expectations.
According to a FactSet Earnings Insight from April 29, 62 per cent of companies in the S&P 500 have reported first-quarter financial results. Earnings growth is negative for a fourth consecutive quarter, down 7.6 per cent year-over-year, but 74 per cent of companies have reported better-than-expected earnings, above the one-year and five-year averages of 69 per cent and 67 per cent, respectively.
That being said, the S&P 500 index is trading at a premium valuation, at a forward 12-month price-to-earnings ratio of 16.8 times, above its five-year average of 14.4 times.
Here's the bottom line. We could see selling pressure persist in the near-term as investors lock in profits, especially with the valuations of many companies stretched, particularly resource companies.
From a technical analysis perspective, Thomas Bulkowski, a respected technical analyst, suggests that equity investors adhere to the following investment strategy: be invested in the S&P 500 index when the index is above the 12-month moving average, and sell when the index drops below its 12-month moving average. Based on this, the moving average gave a buy signal in mid-March.