Macro overview

Today we will put some focus on the US 500 as it remains the dominant global equity index.

Last week we discussed the monthly chart to give a broader perspective, but this week we zoom in a little to the weekly chart. We highlighted in that post how the dominant focus for equity markets remains inflation and earnings compression.

We discussed how higher interest rate expectations were the major driver of equity market falls seen in 2022. However, any future falls could come from earnings compression, which may start to occur in Q4 into 2023 as the economy increasingly comes under pressure from higher inflation

The US CPI data clearly caused some market nervousness, but why it did so is rather more complex. While the actual data was slightly worse than expectations, it was really not that far out of line from the expectations. Instead, what seemed to have happened in the run-up to the data release was some over-exuberance from short-term traders. This lifted the market up high too fast, in the hope the number would come in much lower than estimates. This resulted in a fairly straightforward correction when the number was broadly as expected.

The Federal Reserve has stated all summer that it remains committed to fighting inflation and taking the necessary steps, and it has moved aggressively in the past few months. The likelihood is it will stay aggressive with another 75bp hike next week, with an outside chance of a possible full one percent hike.

For those following the macroeconomic story the CPI data should not have come as a major surprise. Yet many market participants yesterday seemed to have been caught off guard.

For the near term we would expect this volatility to remain, with bouts of FOMO-based buying getting carried away on hopes over actual concrete data, only to be pulled back to reality when the data hits. This environment is likely to continue creating trading opportunities for the more active trader until the macro situation outlook does create more of a consensus.

Technical picture

This weekly chart shows clearly how the US 500 has powered higher since the start of 2020, with the pandemic crash already looking like a rather insignificant blip.

On the chart there is a channel around the 200-period linear regression (blue region) and a channel around the 50-period linear regression (green region).

This shows how through 2022 the market has been negative, because of interest rate hikes, but still remains just within the bounds of the longer-term positive trend.

Can the longer-term positive trend contain the weakness seen in 2022?

Longer-term value investors are more convinced it can, and they are comfortable holding on to positions for the longer term, while shorter-term growth-based traders are understandably feeling more nervous.

A retest of the summer lows still seems quite plausible, but this would require a break under the 200-period trend. Any moves under the 3,600 area would trigger some more outright nervousness, even amongst the value-based investors, as this would then start to question the moves posted from the pandemic lows.

But the consensus seems to be clear. While a test of the summer lows is possible, more serious breaks lower may only occur if earnings compression occurs, or if inflation stays around 9-10 percent. And we don’t have evidence for either of these things.

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