What a crazy start to 2020 it has been…
The outbreak of the corona virus has been at the forefront of the news for the majority of the last two weeks as over 30,000 people have been infected.
We have also seen Trump become equited from his impeachment trial, as well as heightened tensions in the Middle East between the US and Iran. This year could be more of the same as we head into the US General Election and the ongoing Brexit saga.
Volatility has returned to the market causing some wild swings. We are now heading into some major data flows from all major economies as the hot topic of interest rates comes into play. Central banks have been slashing interest rates throughout 2019 as a number of economies hold above recession territory (especially manufacturing). Cutting interest rates is seen as positive for stock prices as it becomes less profitable to hold onto cash.
Above, the grey shaded area represents recessions over the last 60 years. Since the 1980s the FED has been stuck in an interest rate cycle. Everytime the FED attempted to raise interest rates, a recession followed. Looking at the chart you can see the FED began to cut rates in an attempt to stimulate spending however cutting rates has never prevented a recession previously.
It appears history may be repeating itself. In 2018 we saw the FED raise rates aggressively before taking a complete U turn into 2019 taking three rate cuts. The FED are currently on hold, but they remain data dependent on future direction. Are we now heading towards a similar scenario?
Let’s take a look at some charts…
The S&P500 is one of the US major Indices. This chart dates back to 1995, we have seen two recessions/ market crashes in that time. The current market we are in is the longest bull run in history lasting for over a decade. However we are now faced with a similar scenario which has only occurred twice since 1995, that also happens to be when the last two recessions have taken place.
Firstly, we have seen an inverted 10 year to 3 month yield curve. This is when the interest paid on a short term bond is greater than the interest paid on a long term bond. This suggests investors are concerned about the medium-long term future of the market. However, it is not when the yield curve inverts that a recession follows, it is during the acceleration higher. When the yield curve accelerates higher this suggests investors are rushing to the longer term bonds as they are extremely concerned about the immediate short term. The inversion of the yield curve first happened in April 2019.
Secondly, we have now seen a bearish divergence on the RSI monthly charts. A bearish divergence on the RSI is where the market prints fresh highs, however the RSI begins to form lower highs. This suggests the market acceleration could be running out of steam.
Of course it is impossible to call the ‘TOP’ of a market. There could be a number of catalysts for a sharp decline. Heading into the election year could also cause increased volatility in the stock market, if a ‘populist’ such as Bernie Sanders becomes a front runner, you can guarantee stocks will begin retracing from the record highs. Wall Street is scared of Sanders, so this is going to be a very interesting race that is for sure!
Lets not forget we are all waiting to see if China recovers quickly from the Corona-virus. They make up roughly 17% of the global economy. They currently have 80% of their manufacturing industry in quarantine. Major corporations who manufacture goods in China could get hit HARD. This will include: Apple, Tesle, NIKE, Adidas,General Electric, Google, Honda, and pretty much any company you can think of. The next round of corporate earnings are due late March (Q1 – 2020). This is going to be a date every investor needs to be aware of!
Here is an interesting thought: Ray Dalio, a multi billion dollar hedge fund manager, supposedly placed a trade worth over $1billion on a market sell off by the end of March (he placed this trade in November – which happens to be when the Corona-virus first started). This has not been confirmed, however it all smells fishy to me!
What I will say is BE CAREFUL buying stocks and funds at these record highs, being defensive over the next 12 months could save your financial future!