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Dow On Edge of Bear Market, Recession Fears Rise, GBPUSD Tips Financial Stability Fears

Dow On Edge of Bear Market, Recession Fears Rise, GBPUSD Tips Financial Stability Fears

John Kicklighter, Chief Strategist

Dow, Dollar, EURUSD, USDJJPY, GBPUSD and Recession Talking Points:

  • The Market Perspective: USDJPY Bearish Below 141.50; Gold Bearish Below 1,680
  • After the FOMC rate decision was absorbed this past week, risk aversion began to build a head of steam that enveloped open-ended fundamental risks
  • Market conditions are once again my top concern heading into the new trading week with liquidity and seasonal norms threating to catalyze serious fundamental and technical risks

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Dow: Risk Aversion That is Rolling Into Fundamental and Seasonal Trouble

The FOMC rate decision this past week was a meaningful event in as much as the world’s largest central bank once again significantly tightened financial conditions and reinforced that inflation takes precedence over near-term economic expansion and any market tantrums. However, I believe that its simple passing has opened the market up to the exceptional volatility we have recently experienced. There have been lingering systemic fundamental threats that we have conveniently overlooked for months, allowing sentiment to drift unmoored to the traditional motivators of speculative appetite. Yet, without a fundamental event to temporarily distract ourselves from processing the backdrop we are dealing with, it has been easier for the fires to spread. Among the risk benchmarks most interesting to me heading into next week, I’m moving up the so-called ‘blue chip’ Dow index to the top of my threat radar. This index carries the moniker of a ‘value index’ and it very noticeably managed to avoid a technical ‘bear market’ in the selloff through June – when the S&P 500 notched ignominious designation. This past Friday, the Dow came exceptionally close to earning its own scarlet letter, but barely escaped by the close. If that milestone is hit in the week ahead, the flood of headlines alone will prove a burden.

Chart of Dow Jones Industrial Average with 20 and 100-Day SMAs (Daily)

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Chart Created on Tradingview Platform

Yet, whether or not the Dow joins its largest peers in retreating more than 20 percent from its all-time highs, there are some heavy winds that speculative interests are heading into ahead. On the technical side, there are multi-year and decade lows being hit across financial and capital markets assets – spurring a fear of volatility if not an outright concern of risk aversion. Fundamentally, the overlapping issues of unrelenting inflation, rapidly tightening monetary policy and a troubling proximity to a global recession call represents a backdrop whereby a mere ‘bear market’ simply does not reflect the trouble at hand. I will point out that, historically, September is the worst average calendar month of the year for the S&P 500 – resulting in its only loss from 1980 to current. Yet, there are highs and lows around that average. More consistent as a ‘force of nature’ and less a consequence of current headlines is the level of volume and volatility (‘participation’ and ‘fear’) that manifest at this time. On that front, we are looking at troubling seas ahead.

Chart S&P 500 Monthly Performance, Volume and Volatility Averaged from 1980 to Present

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Chart Created by John Kicklighter

S&P 500 and VIX: Projecting the Scale of Pain

I am a firm believer that market conditions are more important than the traditional fundamental and technical influences on which we usually focus our analysis. Whether or not markets are deep or shallow, flighty or stoic can materially alter the impact of a scheduled data release or the break of a technical milestone. That said, we are moving into the final week of September – again, what has averaged out to be the worst month of the year for the ‘risk’ benchmark – and we are already down -6.6 percent with volume and volatility far from peaks. Looking at a more granular picture of the S&P 500’s historical performance, the 39th week of the year stands out. It has averaged out the worst decline for the index of the calendar year. Does it have to repeat this performance? Absolutely not. That said, the backdrop is distinctly unflattering this go around in 2022.

Chart S&P 500 Average Weekly Historical Performance from 1900 to Present

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Chart Created by John Kicklighter

As broad and significant as the market’s retreat has been these past weeks, it still does not register as a full deleveraging of risk exposure. There are two general courses for which markets take when scoping out changes in larger trends. The more practical development is for fundamentals to overall reverse course whereby markets have a firm footing for a recovery. That said, such a shift is slow and exaggerated through the backdrop; and we are seeing little in the way of ‘green shoots’ as the tempo and projections seem to be worsening. Alternatively, a fully speculative ‘flush’ can occur during panics which leads to what is often referred to as ‘capitulation’ (though usually after the fact). That is a scenario in which the market discounts the forecast rapidly and thoroughly such that opportunists are willing to come in and take a risk that the ultimately is in or near. Though the VIX volatility charged to a three-month high close through the close of this past week, it seems far from a true flush. Though it is relative, I’m watching the 50 level on the volatility index as much general threshold.

Chart of VIX Volatility Index with 100-Week SMA (Weekly)

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Chart Created on Tradingview Platform

GBPUSD the Top Fundamental Lightning Rod and a Backdrop that Can Amplify the Mundane

As we move into the new trading week, I will certainly be keeping tabs on the Dow, S&P 500 and VIX; but the FX market may well offer up more of a comprehensive reflection of our financial status than anything else. The US Dollar’s incredible charge is shifting away from carry highlight into the territory of a fundamental burden among investors and observers. The Greenback has pushed EURUSD from its anchor at parity (1.0000) with a darkened outlook for the Eurozone economy taking over. USDJPY is perhaps one of my favorite pairs to keep tabs on for fundamental insight as policy officials (the Ministry of Finance in Japan) is attempting to fight market currents simply following the disparity in monetary policy settings. Yet, GBPUSD is the first place I will be looking in the currency market in the week ahead. The ‘cable’ absolutely collapsed to close this past week. The -3.6 percent plunge through this past Friday was one of the worst day’s for the pair in a decade. Only the height of the pandemic, Brexit and Great Financial Crisis saw worse. Monetary policy differentials matter less here with growth disparity a bigger consideration as the BOE has warned the UK may already be in recession. Yet, it was the reaction to the growth program from the new Prime Minister and Chancellor of the Exchequer that seemed to really push it over the edge. If there are questions around London’s financial stability (relatively), the Dollar is in a good position to take advantage.

Chart of GBPUSD with 20 and 200-Day SMAs, 1-Day ROC and 20-Day Disparity Index (Daily)

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Chart Created on Tradingview Platform

Looking out at the event risk over the coming week, the impact potential of the listings is changed by the shifting mood of the market. The economic and financial fallout from external influences and central bank commitments will amplify the importance of different updates. Tangible economic milestones should be watched most closely. The IMF is due to publish an interim economic outlook on Monday which is about as comprehensive as it gets. However, the Chinese and Japanese September PMIs, US consumer confidence report and European economic sentiment surveys are key listings. I will also be watching for commitment from the different major central banks to ward off the threat of financial instability. There is a long run of Fed speakers, but Bullard’s comments tend to be provocative while the end of the week sees Brainard and Williams talking about financial stability. ECB President Lagarde will once again be monitored to see if she can clarify the muddled message from group attempting to play catch up. And, as for the Bank of England members on tap, the Sterling’s collapse and the warnings of recession will demand addressing.

Critical Macro Event Risk on Global Economic Calendar for Next Week

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Calendar Created by John Kicklighter

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