There was a lot of talk around a ‘pivot’ through the end of 2022. Much of that reference was made in regards to the forecast for the Fed and the broader developed world monetary policy environment. The belief that inflation was coming down from multi-decade extremes was inspiring the capital market bulls to come out of hibernation and once again speculate around the hope for a recovery from the slump over the first three quarters of the year. I suspect the interplay between rate forecasts and market performance will remain a critical driver for the markets-at-large heading into 2023. As such my search for opportunities will heavily draw on that theme and ‘risk trends’ overall.
One of the most direct reflections of investor sentiment in the market is the S&P 500. It represents the most widely traded asset (equities) in the world’s largest market and economy (the United States). It is also one of the most heavily derived benchmarks – meaning derivatives of the index itself such as the emini futures, Spyder ETF and VIX volatility index are top vehicles in their own right. As a blatant representation of ‘risk trends’, it is important to track the general theme of sentiment and its fundamental tributaries closely. Technicals alone will not suffice for me.
Through much of the fourth quarter of 2022, the S&P 500 managed a very productive rally, nearly retracing half of its full losses on the year. However, the technical perspective benefits from a higher time frame. Though the index entered a technical ‘bear market’ (20 percent from highs) in June and touched the midpoint of the pandemic low (March 2020) to record high (January 2022), it is still a very mild correction in the context of the longer-term bull trend from the lows of the Great Financial Crisis in 2008. I don’t think that the markets have grasped the implications around the end of nearly a decade of unprecedented stimulus and the threat of a probable recession in 2023.
Chart of the S&P 500 Overlaid with Aggregate Stimulus from Major Central Banks (Monthly)
Chart Created by John Kicklighter
The Fed and other major central banks have reiterated their commitment to reduce accommodation through rate hikes and balance sheet reductions – even if the face of market corrections and possible recessions. Given the market’s pricing of Fed Fund futures and other products, they remain unwaveringly skeptical of that commitment; but that likely has a lot to do with the comfort that has developed over the last decade of central banks reacting at least indirectly to market tantrums. Their efforts to signal that this norm has come to a close will eventually sink in, but it could take some time. As such, I have a longer-term bearish view of benchmarks like the S&P 500, but criteria for entry are increasingly important. Moving below 3,800 would be the lowest bearish hurdle, while a break below the post-pandemic midpoint at 3,500 (and thereby clearing the 200-day SMA) would be much more significant. This view is against 4,300 where a break would speak to an unrelenting confidence in ‘long only’ investors’ outlook – or an unexpectedly favorable course for the economy.
Chart of the S&P 500, 100 and 200-Day SMAs, June Fed Fund Futures and COT Positioning (Weekly)
Chart prepared by John Kicklighter with Tradingview Charts
When it comes to risk trends, the Dollar has a serious role to play as well. If you followed the EURUSD’s trend through 2022, you may have noticed how closely it mirrored the performance of the S&P 500. The Greenback may have enjoyed its place at the top of the carry charts amongst the majors for an extended period, but it still plays a foundational role that tends to align to the movement of capital to and from ‘quality’. USDJPY is a cross that I have had interest in for some time now, and it remains going into 2023. The influence of risk trends is usual here as both currencies tend to be treated like ‘havens’ (though they represent this for different reasons). With that influence somewhat tempered, my focus then goes to the principal fundamental driver: rate forecasts. If the Fed does indeed have to lower its terminal rate, it is more likely to do so because of a troubling economic backdrop. That being the case, USDJPY is likely to feel the downward pressure. I will Looking for new lows to the reversal below 134 and then subsequent key levels below against a 145 upside.
Chart of USDJPY Overlaid with the US-Japan 2-Year Yield Differential (Weekly)
Chart prepared by John Kicklighter with Tradingview Charts
