By Noel Randewich
SAN FRANCISCO (Reuters) - Sharper losses could be in store for Wall Street. The S&P 500's (SPX) 3.2 percent slump on Monday in reaction to an escalating U.S.-China trade war has added to fears that a prolonged market correction could already have started.
The slide left the benchmark index down 6% from its record high close on July 26. That was its deepest fall from a record high since a 6.8 percent selloff that began in early May and lasted a month, also driven by nervousness about the year-long trade conflict.
Many investors define a stock market correction as a fall of at least 10 percent from a high, often as a reaction to excessive gains.
"We now need to prepare ourselves for a sharper U.S. equity market correction as investors reprice the risk to the economy from the trade war – and the stronger U.S. dollar," warned Seema Shah, chief strategist at Principal Global Investors in London. "The Federal Reserve will now be under severe pressure to cut policy rates again at the September meeting to offset the downside impact.”
Monday's sell-off was sparked after China let the yuan currency tumble beyond the 7-per-dollar level for the first time in more than a decade. It was a sign Beijing might be willing to tolerate further currency weakness in the face of the escalating trade dispute with the United States.
The sharp 1.4% drop in the yuan comes days after U.S. President Donald Trump stunned investors by vowing to impose 10% tariffs on the remaining $300 billion of Chinese imports from Sept. 1, abruptly breaking a brief month-long ceasefire in the bruising trade war.
Trump has measured himself by the success of the stock market, tweeting about its record levels during his administration. He has also lambasted Federal Reserve Chairman Jerome Powell for not cutting interest rates more aggressively in order to support the market.
"I don't think the Fed has the ability to forestall a recession with just interest rate cuts if this trade war continues to worsen," said Robert Pavlik, a senior portfolio manager at Slatestone Wealth LLC in New York. "I'm not saying it’s going to happen, but the president is playing a very risky game here."
The latest salvos between Beijing and Washington have increased fears about a further slowdown of the already fragile global economy.
After the Federal Reserve last week cut interest rates for the first time in over a decade, traders of interest-rate futures are pricing in about a one-in-three chance of a half-point rate cut in September, up from less than a 2% chance for such a large reduction seen on Friday.
(GRAPHIC: S&P 500 correction depth - https://tmsnrt.rs/2Ym1Y4K)
(GRAPHIC: S&P 500 correction length - https://tmsnrt.rs/2MGYyT8)
Over the past decade, the S&P 500 has weathered three declines of 10% or more from a record high close. Following a 14% correction that began in May 2015, the index took 286 days to recover and beat its previous record high. More recently, a nearly 20% slump that started last September went on for 145 days before the S&P 500 reached a new high.
"Given the surge in equity volume that kicked off this correction, we think it is likely that this correction is going to persist for a month or so before renewed buybacks take stocks back up to and through the prior highs," predicted Brian Reynolds, chief market strategist at Reynolds Strategy LLC, in a research note. Reynolds said he believes "this is yet another panic and not a crisis."
(GRAPHIC: S&P 500 sectors since July 26 high - https://tmsnrt.rs/2MEMCBn)
Technology stocks have led declines since the S&P 500 closed at a record high on July 26, the last positive day for the index.
(GRAPHIC: S&P 500 vs chip stocks - https://tmsnrt.rs/2Yu7mmD)
With U.S. semiconductor companies relying heavily on China for their revenue, the Philadelphia Semiconductor Index (SOX) on Monday tumbled 4.4%, its deepest one-day loss since May. The chip index has outperformed the broader market in 2019, with investors piling into the volatile sector on bets that the Fed would lower interest rates and on expectations that the worst of a global downturn in demand may be over.
Other manufacturing and industrial companies that rely on China have also tumbled.
(GRAPHIC: Trade-sensitive stocks - https://tmsnrt.rs/2YrJtMn)