MARKET OBSERVER – N° 163

The examination of the short-term trend of the primary world stock indexes which began at the turn of the fourth quarter offers interesting food for thought already in view of 2023.

In fact, in October there was a generalized bearishness which led the main indexes to test the years’ lows in June, only to then rebound from these levels, thanks to marked short covering. Therefore, with the S&P 500 index slightly above 4000 and the EuroStoxx 50 index slightly below the same 4000 level, we are in the upper part of the 3600/4100 accumulation band of the S&P 500 previously forecast. If, during the next few sessions, the rally continues beyond the 4000 level, there could be a strong short covering rally which could even push the index towards 4200 points. But there is no doubt that stocks are currently overbought, suggesting a selective approach in terms of new positions to be hypothesized close to support at 3850 and, also, the realization of any tactical positions in profit. It is worth recalling that with the stock market crisis of 2022, the buy and hold strategy of the indices worked punctually for almost two decades starting from 2008, albeit now with the reduction of the excess liquidity which inflated the securities markets, a strategy of careful selection of individual stocks ​​will be much more rewarding than maintaining positions in indices as well as in sector ETFs, which risk moving sideways for a long time. The validity of this working hypothesis can readily be seen by observing, for example, the trend of the Eurostoxx 50 index which to date has lost less than 10% since the beginning of 2022, while several of its constituents have tumbled more than 50% in price in the same period, suggesting a recovery potential well above the aggregate.

But the most relevant consideration with respect to the last week, concerns the process of monetary tightening initiated by the major world central banks starting in December 2021, which at the end of October resulted in the drainage of 3.2 trillion dollars to reduce the 9.6 trillion dollars injected since the pandemic crisis of spring 2020. The new action of this quarter is characterized by the 167 billion dollars that the FED has injected into the system since the beginning of October. It seems reasonable to assume that the Board is seriously reconsidering the possibility of continuing with monetary tightening (QT), not only for cyclical reasons, as half of its members expect a recession in the first half of 2023, but also for technical reasons, as the recent experience of the Bank of England shows that the excessive contraction of liquidity can seriously undermine the ability of the treasury to place government bonds. In fact, this year the FED drained 1,080 billion of liquidity from the US system while the much-acclaimed reduction of its balance sheet did not actually occur given that the same today is 8,680 billion versus the 9,000 billion recent high. But the level of the stock market index is directly a function of the liquidity of the FED, just think that the correlation between the two is 0.90%, therefore every 500 billion of liquidity reduction corresponds to about 500 points on the index. So, the fact that the key rate during the next two meetings of the US Central Bank will rise by another 75 basis points is much less relevant than what will be decided in terms of system liquidity. If the hypothesis of being already in a terminal phase of QT proves to be correct and the FED reverses monetary policy by spring 2023, the worst stock market hypothesis could be a triple bottom formation of the indices by next February, while it would be very unlikely that another trillion is drained from the system, as was initially expected, which would have caused the S&P 500 index to drop to 3200. The possible stabilization of US monetary policy followed by a return to credit easing by next spring will certainly influence the parity of the dollar, which has already rebounded above its technical supports in the 1.02/1.03 band against the Euro, with the resistance of the latter placed close to 1.06 which, if broken, would deny further appreciation of the greenback in the medium term. In consideration of a weakening dollar accompanied by the abandonment of the current, stringent, Covid containment measures, would suggest allocation in Chinese stocks, which, however, despite the obvious quantitative undervaluation and the marked absence of international investors, the asset allocation recommendation continues to be underweight.

Nicola Bravetti

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