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The inflation beast is out of control, what next for markets?

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Recent geopolitical events around the Atlantic and Black Sea, plus ‘CovidXX’ in China, has done a lot of damage to all asset classes outside “the dark side,” lasting and even permanent damage.

The inflation beast is out of control, and events are out of the control of the Federal Reserve. The results from current geopolitical changes will have a long and lasting impact. The US/Russia proxy war in Ukraine will remain as an event of the magnitude of the 1989 wall tear down. The events of that year are currently being reversed with regard to trading, psychological and financial risk levels. China´s Covid lock down is a shorter-term logistical event, but as we have learned through the Covid pandemic over the last two years, shorter term events can have longer and more lasting effects; the beast is out.

S&P 500 chart 1
Chart 1. S&P 500, weekly over 2 years (click to view a larger version)

We saw shorter term bullish diverging signals last Monday to work from, indicating that the current move down is over. Both oscillators and internals were showing divergence before, and last week showed they were correct. The speed of this up-move was a surprise to yours truly though, but the relevant question to ask is, what are we currently facing?

Longer term, there are two scenarios to consider here! Was the current down-move a correction in the ongoing upward trend, or have we seen a top for years? Current evidence points to the latter!

If the move down from January 4th was just another dip in the onward trend, we should see lower discounting rates again, which means low inflation should come back, resulting in full risk back on, and the “duration trade” driving markets forward. That is currently not a scenario I can imagine, because of the changing geopolitical landscape plus military action and funding once again driving the world forwards (backwards really).

The more negative outlook or at least longer sideways option makes me zoom in and seek where to adjust risk and rotate into safer asset classes and once again “lower duration assets”.

The weekly chart above shows that the S&P 500 fall was exactly 38,2% from the rise from the March 2020 bottom to the January 4th 2022 top, but the negative stock distribution had already started back in May 2021, so this looks like the bigger picture stuff! Zooming out to monthly charts (see below), participation in the move up since 2020 was not as broad as before 2020, which is why the more bearish outlook gets credit.

S&P 500 chart 2
Chart 2. S&P 500, monthly over 15 years (click to view a larger version)
S&P 500 chart 3
Chart 3. S&P 500, daily over 12 months (click to view a larger version)

The daily chart above has three Fibonacci correctional levels printed in, indicating that I expect this next move to be corrective in a new phase down or long sideways process. Right or wrong, these levels will most probably have significance anyway, at least in the current phase, and first move up.

What we also see is that the Fibonacci levels also correlate quite well with structurally important pivot levels. Near term the current levels around 4,150 to 4,200 should give some resistance, but the real trouble starts around 4,320 and 4,435, which are the mathematical optimal correctional targets upward in the larger and longer-term move down.

If the longer-term bearish interpretation is correct, we will be looking into 3,450-3,500 in Q4 later this year, and if not, the alternative will have to evidence itself in the structure and internals over the summer. For now, I am sticking with the corrective upwards scenario to adjust my positions and risk.

Henrik Mikkelsen is the Investment Strategist and Developer with Iridis AG, an investment advisory in Switzerland.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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