By Veronica Fulton, Research Analyst
The key question on everyone’s mind is – “Is this the bottom?” It’s no secret that based on certain indicators – notably the S&P 500 being more than 20% below its all-time high – we have seen a significant correction in the market. History tells us that corrections provide an opportune time for investors with a longer time horizon to invest money in the market. With only 2% of S&P 500 stocks trading above their 50-day moving average and compressed valuation multiples, it looks like investors are ready to “buy the dip”! Discipline tells us to buy at the absolute low point to minimize downside risk and maximize upside potential. Have we reached this point?
Our team takes a holistic view of the markets to answer these types of questions. Core elements of our process include: Fundamentals – macroeconomic events that influence market behavior, Technicals – trend analysis that gives us insight into investor behavior and sentiment, and Quantitative – rating/ ranking of assets based on factors and other relative measures.
Fundamentally, we believe three key forces are driving the market, and until they change course, we assume we will continue to see further weakness.
The first is rising interest rates, which continue to put downward pressure on bond and stock prices – we wrote about this recently.
The second is the rising dollar. As the dollar is the safe-haven currency, these recent surges of strength have put pressure on international economies as foreign investors scramble to sell their currency in order to buy dollars to service US dollar-denominated debt. Japan is a more extreme case where the strengthening of the dollar and the global rise in yields have a cumulative effect. The yen has now hit a multi-decade low against the dollar. At the same time, the country is dealing with the consequences of its commitment to accommodative monetary policy as the rest of the global economy tightens. Last week, the Bank of Japan had to buy more than $80 billion of Japanese government bonds to defend its self-imposed rate cap. This kind of pressure on the global economy is probably unsustainable.
Finally, the elephant in the room – energy. Years of global underinvestment in new oil discoveries, combined with policies incentivizing green energy, have curtailed oil exploration and refinery expansion in the United States. Currently, the Russian-Ukrainian war is acting as an accelerator, further reducing supply. The events have pushed up oil prices in a global environment where demand for energy is increasing as economies reopen. This energy crisis has been one of the main drivers of inflation. Inflation caused the Fed to react aggressively, which in turn inverted the yield curve, sucked market liquidity and slowed economic growth. Simply put, we believe the market cannot reach new highs until energy prices are brought under control.
In recent days, we have seen evidence that all three of these factors are calming down, but until there is more conviction, we think any attempt at a market rally may be transitory.
Technicians often struggle to tell the difference between an oversold bounce and a significant market bottom. With our technical indicators, we are looking for clear signs of capitulation. Some magnitude indicators, such as the percentage of NYSE stocks above their 200-day moving average, are weak and at levels that historically indicate buying opportunities. However, many other indicators have still not reached washed out levels – namely higher put/call ratios, VIX readings above 40, increased selling volume of large cap names and widening credit spreads would be more indicative of a capitulation. Granted, we could see the market bottom out before each of these items is ticked off, but we think more evidence is needed.
Quantitatively, GLOBALT’s proprietary model ranks asset classes based on a combination of momentum, downside deviation and external factors. Currently, cash takes the top spot when ranked against US bonds, international equities, US equities and REITs – the model suggests the odds aren’t entirely clear as the downside risk is even bigger in all asset classes.
None of these components alone will cause us to adjust positioning, but when combined they have proven to be a powerful tool for navigating the markets and answering timely questions. Based on our work, so that we got to the bottom with conviction, some of the things we mentioned – yields, dollar, energy and technical indicators need to peak first. We are not there yet.
Sources: Dorsey Wright, FactSet, Ned Davis Research, Oppenheimer, Strategas
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