2022-11-20 Sunday Market Update

Past Week’s News:

• US: Retail sales for October (1.3%)
• China: Weak retail sales, came in at -0.5, which is the first decline in five months.
• China: Newly build home prices steady decline, came in at -1.6%
• Both UK’s and Japan’s inflation the highest in over 40 years, came in at 11.1% for the UK, and 3.6% for Japan.

Net Long Source: DailyFX Sentiment

Indices: 30 Days & YTD

Market Update: Indices

Comment: Indices

As stated above, markets feel indecisive and look like they have reached a top since the October rally… Some of the indices like Nasdaq, HangSeng, and Nikkei are looking downwards, while the other indices are stagnating… Looking at the boxplots for the past 30 days, all closing prices are outside the inter-quartile range, and some are even at or near outlier territory… Therefore a short-term recoil seems very likely.

If we zoom out to the YTD graph, we see most closing prices are around the median and mean, which strengthens the idea of a recoil, because if we are in a downward trend, somewhere around the mean is a good place to top, before continuing downwards… And this idea is even more strengthened if we zoom further out at the past 10 years, where we see that all indices (except HangSeng) are above their inter-quartile range, and still have a fair amount of downside before reaching the long-term mean.

One thing to keep in mind, and this is fairly speculative, but most markets participants see what I see, and what can be heard is that most retail investors have increased their short positions… this is one thing that is itching the back of my head and for me the only argument for markets to climb further… either because markets are pushed up for them to get knocked out of their short positions, or if they are forced to close them and buyback, which will fuel for one more spike before the winter/Christmas downturn…

For sectors, we can see that two that stand out on the upside are semiconductors and solar… This seems logical that they both increase extra in this rally because of the speculation in transportation and China opening up, as well as the climate conference COP27 in Eqypt (for solar). Regarding solar and renewable energy, the EU has proposed a “loss and damage”-fund, which purpose is to help developing countries invest in green energy infrastructure (still much needs to be decided before it is actually implemented – more news to come).

Besides these, most sectors are fairly even except for Consumer discretionaries and Internet. I had to recheck the code to see if there was something wrong, but when looking at the sectors, they started and ended the period more or less at 0 difference. The Internet has had a lot of uphill battles regarding negative news from Meta, and similar giants are facing low to no ad revenues. Also, consumer discretionaries should make us more aware that we are facing a recession and we are likely to see consumers save more of their income.

Above I have also added two correlation matrices, one from 2021-01-01 to today, and one that shows a correlation over the past 10 years. In the short-term correlation, we can see that solar and energy are the only ones with a negative correlation to the SP500 and semiconductors. consumer discretionaries and technology are the ones that have the highest correlation with SP500. However, if we zoom out, mining is the least correlated sector with SP500, and the second least is energy.

So how to interpret this matrix and put it into context today? Well, since indices are going down, then you want to look for sectors that correlate as little as possible with the indices, and if they are negatively correlated, then we should expect an upside if we believe that indices are going to continue down. However, why we can see a negative correlation in for example energy is that energy has been soaring this year due to both the war and inflation, and therefore it should give us a negative correlation to SP500. But it is dangerous to take this as an absolute truth because if we zoom out and look at 10 years, well, then all sectors are more or less strongly correlated with SP500. So you can use this matrix for inspiration to find sectors to help hedge your portfolio, as long as you do it with caution… For me, I will upload a bigger analysis project that builds on these matrices and see if we can find an optimal portfolio. 

Market Update: Rates

Comment: Rates

Rates have started to rebound after the initial drop after US’s CPI number. Most central banks have made it clear that they are preparing for a recession, and that they will continue (at least for a while longer) to increase the rates. It is important to not get over optimistic here when we see the rates go down and the markets up, because if the markets go up, then the central banks will continue to increase rates… At the moment, I cannot see any pivot in the short term, and for now, I stand that the pivot is most likely after the annual reports, and after the first quarter of 2023… that is when we can actually see how much this recession has/will affect companies and the economy, and if it look really bad, this is a good enough incentive for the central banks to start stimulating again. But before that, I would not hold my breath…

Market Update: FX

Comment: FX

For FX we see that the USD continues to weaken, and this is in the after-match of lower CPI, higher markets, and lower rates… However, now that the markets look like they have run out of fuel and will start to decline, this might lead to a further strengthened USD. In the boxplots, we see that the USD is around the whiskers on either the top or bottom (depending on if USD is the quoted pair or not), and I would not be surprised if we see further strength in the USD in the short term.

Market Update: Commodities

Comment: Commodities

Since last week, commodities have been decreasing somewhat, but this does not change my view. I believe this is just normal trend fluctuation, and that they have started a positive trend and will continue upwards. If we look at the YTD graph, it looks like they have bottomed and are not starting to gain traction upwards. So this, in combination with declining indices, and a stronger USD, is the perfect condition for commodities to increase.

Worth mentioning though, as stated in last week’s update, is that even though I believe in the commodity super boom, this is bittersweet, because commodities are real, and here, higher commodities affect almost everything in the economy. So higher commodities = higher inflation (and everything bad that comes with it). Just one asterisk to keep in mind…

Summary:

• Markets are indecisive but looks like they have hit the top and are about to come down. Risk appetite is declining and the markets are more cautious… I believe that we should prepare for a market downturn, which will make USD, rates, and commodities go up.
• In the sectors we see that the biggest increase in the past 30 days has been from semiconductors and solar. The worst performing indices have been internet and consumer discretionaries, that has closed at 0.
• Be careful out there, most retail investors have been loading on short positions, and are long gold and USD, which unfortunately usually means that the markets are going in the opposite direction… So this might make the markets spike one more time before turning down. If uncertain, it is better to be outside the market and then trade when the trend becomes clear. Better to miss a few percent in the beginning, than be caught in a painful trade.

Next Week:

• 23 Nov. FOMC protocol
• Preliminary PMI in the US, EU, and UK