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Market Update - A shaky start to the New Year


Market Update

A shaky start to the New Year

Well, that’s January out of the way, and many will be glad to see the back of it. Not just because we’re one month nearer to Spring, but also on the hope that the stock market blood-letting that kicked off the year could now be over. With losses of 5.3% and 9% respectively, the S&P 500 and NASDAQ 100 both posted their worst months since the coronavirus slump in March 2020. In fact, both indices put in their worst January performances since the Great Financial Crisis in 2009. It was only the sharp rally over the last two trading sessions of the month that saved the NASDAQ from posing its worst January ever.  

Correction territory

On Monday 24th January the S&P 500 tumbled to 4,221 – a level not seen since last June. Otherwise, 4,270 has acted as support, just as it did in July and October last year. The sell-off from the intraday high hit at the beginning of January to the 4,221 low took just 20 days. It was a move of over 12%, which represents a ‘correction’ in market parlance. We then saw a sharp rally which took the index back above the 200-day Exponential Moving Average (EMA) around 4,440. The S&P went on to break above 4,500 which is where it’s trading at the time of writing.

Strong reversal

So, has the fever broken or are we in the eye of a storm with more upheaval to come? The short-term bull argument rests on the fact that the S&P was extremely oversold last week. In fact, the index was more oversold than at any time since the March 2020 pandemic sell-off. That helps explain the sharp rally in the latter half of last week. Everyone who wanted/needed to sell had done so, suggesting that the only way was up. The Moving Average Convergence-Divergence (MACD) shows that the S&P remains oversold, although it has started to turn upwards on the daily chart. So, there could be more upside to come. But, again considering the short term, we are now approaching levels where there could be significant resistance. While the S&P has cleared the first major upside hurdle at the 200-day EMA, it is now entering an area of potential resistance between 4,500 and 4,550. It has rallied around 7% in a week, so the possibility of a pull-back shouldn’t be ruled out.

Another sell-off?

Could the index hit a lower low? Again, it’s a possibility even if it doesn’t feel likely at current levels. Sentiment is extremely fickle at present. We moved from the ‘Santa Rally’ trading trope to the ‘as goes January, so goes the rest of the year’ cliché. Bear in mind that we’ve been on a bull run for 22 months now, and this is the deepest correction we’ve had since it began. Even the shallowest of dips have proved to be buying opportunities, but could it be different this time? Last year’s action was typical during the heart of bull markets where prices grind higher with shallow pullbacks. This makes it very difficult for those on the side-lines to get involved. The relentless gains only go to frustrate traders who haven’t already bought, sparking the dreaded FOMO (Fear of Missing Out). Yet many are understandably scared of buying at what may prove to be the top. So, they sit on their hands, becoming ever more impatient, waiting for a significant sell-off which never seems to come. Then when it does appear, the size and speed of the fall often terrifies investors who understandably fear a larger decline, so fail to take advantage of lower buying prices.

Crash alert?

Indeed, a significant number of commentators maintain that a full-blown crash is on the cards. This is understandable, particularly when looking at US equity markets where the major indices are historically overvalued. Within these indices you have companies like Tesla, which, despite selling less than 900,000 cars per year, or around 1% of the car market, has a market capitalisation just under $1 trillion which makes it worth around the same as the next 10 most valuable global automakers combined. Tesla has a price-earnings ratio of around 190 (down from 332 at the beginning of the year) in an industry where PE ratios of 10 to 30 are typical.

Higher rates coming

Investors are concerned that the days of cheap borrowing are coming to an end. The US Federal Reserve has made it clear that it is targeting high inflation and that it will be raising interest rates this year. The market reckons the key Fed Funds rate could be 100 basis points higher by the start of 2023. In addition, the Fed has said it’s preparing to reduce its balance sheet which is currently just under $9 trillion. The last time it attempted this as it raised rates saw a 20% slump in the S&P 500 in the final quarter of 2018. Bullish investors can argue that this is what the market is actively pricing in, and they could be right. Equities, especially those in the tech sector, are overvalued by a variety of measures, propped up by monetary and fiscal stimulus which are keeping borrowing costs at historically low levels. If inflationary pressures continue to grow, higher interest rates and bond yields are inevitable. Some say this would damage economic growth so earnings and revenues will suffer. Higher borrowing costs will crimp demand, and force governments either to cut spending, or print more money and deal with even higher inflation, which could spiral out of control. On the other hand, even after raising rates by 100 basis points, real interest rates (which take inflation into account) will remain deeply negative, so there shouldn’t be too much to worry about.

Earnings season

In the meantime, the fourth quarter earnings season is chugging along quite nicely. So far, around a third of S&P 500 constituents have reported so far and close to 79% have beaten earnings forecasts. This is helping to improve investor sentiment, even if the earnings improvement is lower than this time last year. There’s still plenty to mull over as we head further into 2022.

 


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