It was always difficult for humankind to cope with change, and it is even harder to realize how much the macroeconomic landscape has changed in the past couple of years. The unseen economic impact of the pandemic forced central banks to cut interest rates and boost market liquidity to record levels. In this environment of extreme liquidity and zero (risk-free) returns, the rally in equities and other hard assets was completely reasonable and expected. As reasonable and expected was the correction we saw lately. Let’s not forget that from the March 2020 lows, equities rallied over 100% without a major correction.
Macroeconomic Landscape
Currently, economic growth is significant all over the world. During the first two quarters of 2021, the GDP in the US grew more than 6%, while in the European Union the growth rate is more conservative. Unemployment remains high but shows signs of improvement. In the US, unemployment is close to 5% while in the European Union close to 7%. However, the greatest concern for Western economies is neither growth nor unemployment, it is inflation.
Inflation, Money Supply, and Money Velocity
Historically, high money supply and tight interest rates have led to higher inflation. It is noted that inflation is the product of money supply and money velocity (supply X velocity). The velocity of money is a measure of the number of times that the average unit of currency is used within a given time period to purchase goods and services. In simple terms, money velocity refers to the speed at which money moves in the market. As the pandemic loses momentum and money velocity increases, inflation begins to show its teeth. The recent rise in fuel prices makes things far worse. In September, annualized inflation in the Eurozone rose to 3.4%. However, that was before the fuel prices rally. As the data shows, the inflation in the next few months may break all records.
Higher inflation could accelerate tapering and a significant rise in the level of interest rates. Before moving further, let’s see what the financial markets have discounted:
- FEDs tapering in November 2022 (latest FED forecast).
- Interest rate rise at the end of 2022 (current forecast based on FED watch tool).
The rally in fuel prices threatens to cause serious fiscal and monetary troubles. At present, however, there are no signs of a willingness to change monetary policies in both the US and the Eurozone.
Fundamental Landscape of American Markets
According to early October 2021 data:
- Dow Jones P/E 23.1 and dividend yield 1.87%.
- The S&P500 P/E 30.0 and dividend yield 1.38%.
- The Nasdaq100 P/E 34.1 and dividend yield 0.72%.
If we assess P/Es from a historical perspective we may conclude that the American stock markets are about 30% more expensive than they should be. However, given the high GDP growth for 2021-2022 and the almost zero interest rates, the above fundamental figures are not too expensive. The Dow Jones P/E 23 in the current macroeconomic landscape is reasonable, while the 1.87% dividend yield is quite positive. But perhaps the factor that should concern the equity markets more today should be the impact of rising fuel prices on corporate profitability.
Finally, we must mention the problem with the bankruptcy of the Chinese Evergrande. The $300 billion Evergrande bankruptcy is significant but not condemnatory. What is most worrying is a possible Domino effect in international markets. We will have to wait and see what the reaction of the very unpredictable Chinese government will be.
Technical analysis
From their lows of March 2020, until today, the equity markets have rallied a lot, without a significant correction. Indicatively, Nasdaq100 rallied about 130%, and the higher correction was about 14%. Historically, this phenomenon has led to abrupt downward movements such as the one we see today. The first target for US markets is the 200-day moving average (SMA200). Maybe a little later the markets will move even 10% below the 200-day moving average. The market will probably offer significant opportunities to those who have kept significant cash liquidity. The technical analysis shows a continuation of the correction but at reasonable levels.
Chart: Daily (D1) Nasdaq 100 and basic technical analysis
In the above chart we can see Nasdaq 100 along with its 200-day moving average (blue), Fibonacci Retracement on the left, and below the RSI Precision. RSI Precision seems to reach oversold levels, but it still has room to move downwards. (more about RSI Precision)
Conclusions
Growth and the zero-interest-rate macroeconomic landscape remain particularly positive for equities. Moreover, the fundamentals are not too expensive. However, a further rise in fuel prices and the Domino effect of the Chinese Evergrande threaten to ruin the macro-bull party. As concerns technical analysis, it is bearish. In the next few months, the market will offer significant opportunities to those who have kept significant cash liquidity.
■ The Stock Market in 2021-2022
Giorgos Protonotarios, Financial Analyst
for TradingCenter.org (c)
5th of October 2021
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