MARKET OBSERVER N. 160

The working hypothesis that provided for a prolonged phase of distribution in the dynamics of stock markets, which have characterized the first part of the summer period as an alternative to a seamless continuation of the bearish phase underway since January, was found to be correct.

The recovery of the markets, quantifiable in a few percentage points depending on the indices considered, however, struggled to recover, given that after the previous technical rebound in April, it was necessary to wait until the second half of July to witness the foreseeable recovery from oversold levels. To quantify, we refer to the USA S&P 500 index, which reached a minimum in the area of 3650/3700 for the period from which the recovery gradually developed that brought the index to the current value of about 4150. The minimum for the period was recorded at the end of June following the decision by the primary Western central banks, the Fed and the ECB in particular, to accelerate the monetary tightening process already initiated at the end of 2021, to cope with the inflationary pressure due to the post-COVID supply-chain bottlenecks. In essence, for the stock exchanges the second half of the year commenced under a cloud of a new important uncertainty, that linked to the possible will of the monetary authorities to create an economic recession to face the vicious inflationary spiral induced by the exponential increase in energy prices. It is worth noting that the current inflationary phenomenon presents a characteristic that recall the price increases that characterized the decades following the economic boom of the 1960’s. In fact, inflation faced by central banks since the early 1980’s, was the classic phenomenon caused by the concomitance of increase in demand due to the strong economic situation of the period and the increase in the costs of raw materials and labor, while now the increase in prices is totally and solely attributable to the cost factor, while there is not a problem related to an excess in demand, if not to the contrary. Then it might be legitimate to ask whether imposing the cost of a recession on individual economic systems is the correct policy, as the risk is that the impact on the control of energy prices could be much milder than expected. Therefore, the current phase of adjustment of the indices, certainly linked to the marked technical oversold levels reached at the end of June and also favored by the slowdown of tightening implemented by the FED which in recent weeks has reduced the pace of tightening to 3% from the previous 20%, it should be interpreted as a distribution phase, which is a prelude to a further decline as autumn approaches.

This further correction would occur when international investors are convinced that a soft landing for the economic situation will not be possible and that therefore the stock market valuations will be correct downwards in order to take into account the contraction in corporate profits. To quantify the risk of this second part of the current bearish phase, in the worst case scenario we could reach the 3200 level on the S&P 500.

Putting the US stock market situation in perspective, it should be remembered that in spring 2009, in the aftermath of the banking crisis, the index stood at about the 700 level, so in the 12 years up to 2021, it gained 7 fold. When in June the Fed found itself having to decide whether to risk a recession by causing a sharp stock market correction or to tolerate an inflation rate that would have impoverished the US middle class, it chose to deflate stock prices, hence the thesis that the correction will continue towards late August. Even the hypothesis that the dynamics of the Chinese economy, second in importance only to the US, can avoid a global recession thanks to the fact that the central bank, PBOC, has not yet implemented a significant monetary stimulus, as the others cntral banks have done in the aftermath of the Covid crisis, risks being weak fundamentally. In fact, the constant outflow of capital from the Chinese financial market and the strength of the dollar does not seem to allow for the authorities to ease monetary policy, despite the weak domestic economic situation due to the supply chain issues linked to the recent resurgence of the pandemic.

Nicola Bravetti   Data Source: Bloomberg

Data obtained on 05.08.  16:00 GMT

“This report cannot – nor can – be considered a solicitation to invest in financial instruments”