Expected market correction

In the US, Wall Street anticipated the correction. As investors and traders know only too well, fundamental valuations and technical analyses have been ignored for some time. What's worse, markets have shrugged off a series of international signals, including the plunge of energy prices, stagnation in Europe and Japan, decelerated growth in emerging economies, violent turmoil in the Middle East and sanctions against Russia.

In the markets, excessive leverage and liquidity is like manna from heaven. The problem is that it supports hollow valuations. And ultimately, that's what caused the US turmoil.

US markets have been exceptionally expensive for some time. As measured by the so-called CAPE, or cyclically-adjusted price-to-earnings ratio, the historical average in the US market has been about 15. Until the market turmoil, it was 26, which was close to its previous peak right before the global market plunge in 2007.

In the past half a decade, the US economy has enjoyed extraordinarily low rates, rounds of quantitative easing amounting to US$4.5 trillion, and the rapid rise of sovereign debt to US$18.4 billion as of today. Nevertheless, the US Federal Reserve plans to begin the first rate hikes in the fall.

Not all economic indicators support such plans. Unemployment rate is now 5.3%, but long-term unemployment remains excessively high. What's worse, inflation is likely to stay around 0.1%-1% in the fall, which is well below the Fed's 2% target.

If the Fed's hikes are not timed and sequenced right, they could sink the markets, which would quickly force the Fed to resort to a new series of rate cuts. The consequences would be adverse to both the U.S. and the world economy.

That's precisely why the International Monetary Fund (IMF) has asked the Fed to defer its rate hikes to 2016. A premature rate hike would harm ordinary Americans, China, emerging economies and global growth prospects.

The author is a columnist with China.org.cn. For more information please visit: http://www.ccgp-fushun.com/opinion/DanSteinbock.htm

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