Chris Weston, Head of Research for Pepperstone offers his weekly analysis of what’s brewing in the markets.
After a 19% rally in the S&P500 and 24% in the Nasdaq from the June lows, we are now testing the 50% retracement of the June-August rally. The question that is being most heavily debated? Will we see the June index lows being re-tested and was the move just a bear market rally?
Talking to traders, the list of concerns is vast and good news is hard to find. Here are some of the main reasons that market participants are worried and why we are seeing a sharp move lower.
- Fed chair Jay Powell channelling his inner Paul Volker on Friday is hard for the market to absorb. It was purposely short and sharp. Powell’s speech was designed to shut off any possible dovish interpretation
- While the US Aug CPI print (on 13 Sept) will be key if we get a big US payrolls print this Friday (consensus 300k), the market should firmly price the Federal Reserve to hike 75bp on 21 September and take expectations for the fed funds rate above 4% in 2023.
- The Fed is now acknowledging that US households will have to go through some degree of economic hardship. A US recession (over the coming 12 months) is currently priced at 50%. I think this is fair but many will say this seems low.
- The 19% rally in the S&P500 from the June lows was premised on a closing of bearish bets. Given the recent rally, we are firmly positioned more neutrally now. It seems the time to re-establish bearish bets and apply ‘cheap’ hedges are in play
- The Fed is due to ramp up its balance sheet reduction program or Quantitative Tightening (QT) in September to $95b. This is the process of reducing its holdings of securities (US Treasuries and Mortgages) by $95b p/m. As with any typical accounting practice, a reduction is assets needs to be met with a reduction in liabilities. In this case, reserves. Statistically, we know US equity indices and Fed reserve liabilities have held an 80%+ 20-day rolling correlation
- Month-end pension fund rebalancing flow. Flow desks report a rebalancing out of equity and into bonds
- China remains weak (economically) and the UK/EU have a major energy crisis unfolding. EU Natural Gas prices aside, Gazprom closed the Nord Stream 1 pipeline this week for maintenance. Will it come back on?
- The USD is breaking higher and is a wrecking ball for risk. The higher it goes the greater the risks to earnings and the global economy
- US real rates (i.e. US treasury yields subtracting inflation expectations) are on the march higher, especially 2yr Real Rates. This is the real cost of capital, and it is moving sharply higher
- S&P500 Consensus EPS for the FY is $226. This seems far too high
- It all sounds quite dire. Apologies. Perhaps the best piece of news is that so many are turning bearish. Still this dynamic favours weakness and lower levels.
Is sentiment too bearish again or are the buyers catching a falling knife? What’s your position?
Hear from Chris Weston on the latest Pepperstone podcast
This article is brought to you in association with Pepperstone. All opinions expressed in this article are from the author and do not necessarily represent the opinions of The Armchair Trader.