Trader: “Stock Slump Clears The Decks For The Real Storm”

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By Bloomberg Markets Live commentator Christopher Antsey

It’s been said of the Roman army that their training drills were like bloodless battles, and their battles like bloody drills. Something similar may be true of the market this year: the sell-off across asset classes is like a tough drill that will leave it in a stronger position to cope with the real battle ahead — the reversal of QE.

The near 7% tumble in the S&P 500 Index from its record high has been termed a “healthy correction” by so many that it’s practically a cliche by now. But as short-volatility trades clear out, a swathe of speculative and leveraged positions will have been removed.

Retail investors will also have had the fear of the gods put in them: clients at TD Ameritrade had boosted equity allocations for 11 straight months through December, pushing the brokerage’s Investor Movement Index, which tracks client positioning, to a record.

And traders are unwinding positions at a time when liquidity is still abundant — the big three central banks are, on a collective basis, still expanding their balance sheets. Contraction probably won’t begin until October at the earliest, when the European Central Bank could end its asset purchases.

In addition, the shakeout comes at a time when the underlying economic fundamentals are solid — the world is still enjoying the glow of a synchronous expansion. The IMF less than three weeks ago boosted its global forecasts for 2018, seeing the fastest growth since 2011.

So even though the sell-off in stocks and bonds in recent weeks will end up being painful for many, it will build up some scar tissue for the far more serious challenge to come: coping with higher borrowing costs as the unprecedented balance-sheet unwind begins in earnest, removing a backstop for markets that’s been there for a decade now.