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Hope

13 March 2023 By PDSNET

Last year, in the middle of June, we published an article, “Bear Trend”, in which we stated unequivocally that the share markets of the world, led by Wall Street, were definitely in a bear trend . In that article we suggested that the bear trend would go on for 2 years or longer, broken by rallies, and that the safest strategy for private investors was to watch the slope of a 300-day moving average and wait for that to turn upwards before buying back in.

We have also continuously said that the Ukraine war precipitated the bear trend about 18 months early resulting in substantial misplaced bullishness which clings to and has become an enduring feature of the daily market action.

Now, 9 months after writing that article, the S&P500 index, which is the benchmark for stock exchanges around the world, including the JSE, has brushed aside much of that residual bullishness. The third rally on Wall Street came to an abrupt halt on 8^th February 2023 when it failed to break above the well-established support/resistance level at 4170. We sent out a tweet on that day to draw your attention to that change in direction. To follow our tweets go to: https://twitter.com/PdsnetSA.

The bulls in the market took heart from the US Federal Reserve Bank’s relatively small 25-basis point interest rate hike in January and the dovish comments of Jerome Powell to journalists following the monetary policy committee (MPC) meeting. It is now apparent to us that, as they did before the January meeting, Powell and the MPC once again underestimated the strength of the US economy, hinting that interest rates were close to peaking.

The January jobs figure was a rude shock with over 500 000 jobs created and that has now been followed by February’s 311 000 jobs created. This latest figure was about 90 000 higher than the average of economists’ predictions for February – but then economists’ predictions, along with the MPC, have under-estimated job creation in the US economy for the past 11 months. It is little wonder that millions of hopeful novice investors have taken their lead and driven the market up when it should have been falling.

To this scenario you must add the false “golden cross” buy signal on 31^st January 2023 which further encouraged the bulls. The 50-day exponential moving average is now falling quickly and we expect a golden cross “whiplash” sell signal soon.

Consider the chart:

 

 

This chart shows the progress of the S&P500 index over the past 6 months. It begins with the cycle low of 3577 made on 12^th October 2022 and shows the progress of the third rally in the current bear trend. As indicated, that rally ended early in February 2023 when the index failed to break above 4170.

Then, just as the S&P was beginning to fall, we had a flurry of bullish optimism caused by the remarks of Governor Powell in early March before reality was brought home by the February job creation figures. Now the index is in free fall and our prediction that it will break below the 3577 cycle low of October last year is looking more and more probable.

While you are considering the above chart take note that the “golden cross” moving averages are moving back towards a downward crossover.

And then there is the 300-day moving average (red) which is still declining steadily. We indicated in our article in mid-June last year that the slope of this line is one of the most reliable tests of when the bear market can finally be said to have ended and we are still of that opinion.

In our view, far from ending, this bear trend has only just begun. The US economy, which leads the world, is still far from entering a recession as the February job creation print shows. America still has negative interest rates – in other words, the inflation rate is still higher than the level of interest rates. When real interest rates are negative, there is no incentive for consumers and businesses to save – in fact the opposite is true because the purchasing power of their money is being eroded.

Above all, as a private investor, you must hold onto the reality that during a bear trend the probability of shares falling is always considerably higher than the probability of them rising.

In a bear trend the last thing to die is hope.

 

Postscript: The SVB Collapse:

The shock announcement that Silicon Valley Bank collapsed has rocked financial markets – it is the 2^nd largest bank failure in American history – and the second one in a week, after Silvergate. The fallout from this announcement should not be substantial, nor should it cause a run on other banks, a change in the MPC’s approach to monetary policy tightening or a fall on Wall Street. The reasons this are that:

• SVB was only the 16^th largest bank in America, and it was mainly focused on providing finance for start-ups.
• Smaller bank collapses are quite common in America and every year sees some.
• SVB was very heavily invested in bonds – so the pattern of rising interest rates has caused the value of those bonds to fall rapidly. The major banks in America do not have this type of exposure.
• Rising interest rates have also been putting pressure on many of SVB’s hi-tech clients causing them to withdraw funds which impacted on the bank’s solvency ratios. This is an effect which would not occur in other more diversified banks.

Having said that, panic is a strange and unpredictable thing. Wall Street is already in a bear trend and the last two days of last week saw the S&P500 index offload 3,3% bringing the fall since the beginning of February 2023 to 7,6%. Negative sentiment can gain its own self-fulfilling momentum during a bear trend. At this time, the collapse of SVB could have a disproportionate impact on markets.