The Catalyst for a Market Correction Turned Out to Be Something Unexpected
Investors ignored compelling bearish arguments for months, until a different one, which Jamie Dimon warned about, triggered worldwide selling Thursday.
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For months, investors have been ignoring bearish warnings about valuations, bubbly action, inflation, and a slowing labor market. Although many investors acknowledged the need for corrective action, none of the compelling and logical bearish arguments have been embraced.
That shifted suddenly on Thursday when the credit health of regional banks became an issue. While there has been some talk about credit issues, it hadn't mattered to the market until this week, when Jamie Dimon, CEO of JPMorgan Chase (JPM) , addressed the issue during the bank's third-quarter earnings call. Dimon highlighted several concerns, including a $170 million charge-off related to losses from Tricolor, a subprime auto lender.
Dimon also warned of hidden risks in the private credit sector, likening them to "cockroaches" that could emerge. Dimon was not only concerned about lending, he also noted "signs of softening" in consumer and job growth.
Dimon's warnings proved prophetic when news emerged on Thursday afternoon that Zions Bancorp (ZION) had announced a significant loss and accused some borrowers of fraud. This news triggered an aggressive selloff and ignited worries around the world about credit quality.
Early on Friday morning, the S&P 500 is trading down more than 1%. Regional banks remain the primary focus, with portfolios averaging 44% commercial real estate exposure compared to 13% for large banks. Office loan delinquencies are at 10.4% and have raised concerns about some of the same issues that arose during the 2008 meltdown.
The big question now is whether the credit issues are triggering a major market top and a deeper correction. There is a significant shift in sentiment, and the downside follow-through on Friday is a change in character. The most critical issue now is whether there will be dip buyers in technology and other sectors, while the banking sector struggles with this problem. The short interest in the regional bank index ETF (KRE) is now at 30%.
This corrective action is taking place as the market awaits the start of third-quarter earnings for technology and other areas not impacted by commercial real estate. The focus will shift to these individual reports, which will be quite different than the challenges faced by real estate lenders. However, once momentum is broken, there is likely to be a rush to look for profits before another shoe can drop.
Losses pile up quickly when market conditions shift this fast, and it is important to try to reduce risk but not make emotional decisions. It is likely that Treasury Secretary Bessant will move quickly to calm markets.
At the time of publication, Rev Shark had no positions in any securities mentioned.
