Is the Santa Rally over before it began?

Investors should brace themselves for a bruising session as our market is likely to suffer big losses today as optimism on global trade gave way to fear.

The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index crashed 1.7% at the open with the Afterpay Touch Group Ltd (ASX: APT) share price, CSL Limited (ASX: CSL) share price and WiseTech Global Ltd (ASX: WTC) share price among the biggest losers.

The big losses by ASX shares jeopardises the seasonal end-of-year market rise that’s affectionately called the Santa Rally.

Is the Santa Rally over before it even began?

What’s driving the meltdown

To answer this question, we will need to understand the factors that are driving the market meltdown – and that’s not an easy thing to dissect as there doesn’t seem to be any one reason for the weakness.

Growing doubts that US President Donald Trump and Chinese leader Xi Jinping can find a way to bring the ongoing trade war to an end is one of the key factors that sent global investors scrambling for the exits, triggering an 800-point sell-off on the Dow Jones Industrial Average last night.

But it’s unrealistic to believe that tangible and complex trade deals can be reached over dinner, and what was achieved (having a framework to guide future negotiations) is really a win given the sabre-rattling before the dinner.

There could also be cultural factors that prompted the White House to prematurely announce agreements, such as the removal of Chinese tariffs on US automobiles.

When Americans shake hands, it indicates the end of negotiations. When the Chinese shake hands, it signals the start.

The other factor that is pushing markets over a cliff is the inverted yield where the yield on longer-term US government bond (called treasuries) is lower than the short-term treasuries.

This inversion is seen as one of the more reliable signals of a US recession and the bears are using this as an excuse to sell risk assets.

However, this isn’t the case across the curve (meaning most of the shorter-term treasury yields are still below the longer-dated treasuries).

Growing political turmoil in the UK over Brexit negotiations is also contributing to the souring in risk sentiment as Prime Minister Teresa May is fighting for her political life to get her party to back the deal she’s struck with the European Union.

Predicting political outcomes can be much harder than forecasting markets.

Foolish Takeaway

These factors have created a high wall of worry for investors to scale as we head into 2019, although I suspect we will still see a relief rally in the week before Christmas.

This is because these risks have not convinced me that the bull market is over. There are several positives that investors are just choosing to ignore right now.

I don’t think the bulls will be sitting on the sidelines for long – not when the market is pricing in the chance of an interest rate cut by the US Federal Reserve in 2020.

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Motley Fool contributor Brendon Lau owns shares of AFTERPAY T FPO and CSL Ltd. The Motley Fool Australia owns shares of AFTERPAY T FPO and WiseTech Global. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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