MARKET OBSERVER – N° 162

The next two weeks for the stock market preceding the mid-term elections for the partial renewal of the US Congress, could involve unexpected news, in the sense that the Biden administration, confronted with the serious risk of losing both chambers, even if in the Senate there still exists a marginal advantage for the Democrats, he would still have time to propose further initiatives regarding the Ukrainian conflict, before eventually becoming a “lame duck” president, with consequences that are difficult to assess.

In addition, the Communist Party Congress opened in China which will likely confirm a third five-year mandate to President XI Jinping, who from a renewed position of strength could support with greater incisiveness the need for an imminent solution to the Russian-Ukrainian conflict, which penalizes the world economies and therefore the Chinese economy. But leaving aside these elements of geo-political uncertainty, the recent dynamics of stock indices offers interesting food for thought, considering the technical framework of the US S&P 500 index as a reference. Since mid-September, the index has traded in a lateral trend that set its minimum near the 3600 level, not surprisingly this is the lower limit of the support area already reached last June. More specifically, the high volatility of the last week led the index to close just below 3600, on the value of the 200-day moving average which would represent an important support. The next support is at the 3500 level which coincides with the retracement of 50% of the entire bullish move from the lows of spring 2020 to the high of last January. Below that level, we would find the Fibonacci support level at 3200, a bearish target that does not seem within the reach of the current market dynamics.

Therefore, it could be assumed that the index is in an accumulation phase and that the levels indicated may represent a minimum for the period, from which to possibly start a year-end rally, thereby correcting the marked oversold state of current share values. To support this hypothesis, it is necessary to find constructive signals from a fundamental point of view, starting with the level of global liquidity which seems to have stabilized in September, mainly thanks to the slowdown in the credit squeeze implemented by the ECB and in relation to liquidity injections implemented by the Chinese Central Bank. If the liquidity cycle, usually of five years, were at a minimum, we are at the levels of 2018, the exit from the current recession, not yet overt, would be favored by three elements: a change in the Fed’s monetary policy; the continuation of credit easing in China and a further drop in the price of oil, given that the energy sector absorbs a lot of liquidity.

The probability that these three elements can be realized is directly related to the severity of the global economic situation, caused by a contraction in the liquidity of the dollar area, worse than that of 2008/2009. The proof that we are already confronted with the recession desired by the Central Banks, is obtained by observing the risk premium of sovereign bond yields, which in the case of the dollar, are close to historical lows, indicating the expectation of investors for a marked economic cooling. It is interesting to note that along the lines of what has been implemented by the Bank of Japan since 2016 and the central bank of Australia this year, not to mention the very recent intervention by the Bank of England in support of government bonds, the monetary authorities are using a new system liquidity management tool, the “yield curve control”, or YCC. By conveying to the markets a desired fixed return on the long-term bond, which maintains only a moderately positive yield curve, the Central Bank achieves a stimulus effect by committing far fewer resources than traditional open market operations with securities (QE), invalidating the recessive significance of a negatively oriented curve, favoring the profitability of the banking sector with the restoration of a positive yield curve and improving the expectations of equity investors. Contemplating that the evidence of a recession will be gradually formalized by the statistical data of the individual economies starting from the end of the year, the possible gradual easing of restrictive monetary policies could be expected in the second quarter of 2023, the timing of which would be compatible with an attempt by the stock markets to rebound during the last months of this year.

Nicola Bravetti Data Source: Bloomberg

Data obtained on 17.10 14:00 GMT

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