- Nasdaq underperforms US indices
- Rising bond yields and aggressive rate hikes are bad news for tech
- Recession signals around the world should weigh on risk appetite
Although the US markets managed to eke out gains on Thursday, there are plenty of reasons why stocks could be heading lower.
Before discussing the macro reasons, let’s start with the technicals as after all this is meant to be a chart-based analysis.
Hanging man
On Tuesday, we got the first indication that the bullish trend was beginning to weaken. The Nasdaq formed a hanging-man-like candle that day, which was then followed on Wednesday by the print of a large bearish candle that took out short-term support around 13550, a level which has since turned into resistance.
Thursday’s indecisive price action is perhaps a positive sign, but if the low of Thursday’s range gives way, which is what I am expecting to see, then I would imagine more technical selling will be the outcome. Perhaps the potential sell-off might wait until next week. But we have certainly had some tentative bearish signals after the big recovery.
Nasdaq weakest compared to other US indices
The tech-heavy Nasdaq has been the clear underperformer among the US indices in the rebound that started in June, which makes it the most vulnerable. Other US indices have outperformed, underscoring the view that falling government bond prices are bad news for low-dividend-yielding technology stocks.
The Dow, for example, has already reached its 61.8% Fibonacci retracement level against its all-time high, while the Nasdaq is nowhere near as it has barely passed the shallow 38.2% level.
What’s more, the 200-day average (which, on a side note, now has a downward slope on all US major US indices), has already been reached and breached on the Dow, Russell and tagged by the S&P 500. But not the Nasdaq.
Thus, if the markets are going to start falling then shorting the already-weak Nasdaq will make more sense than something like the Dow, which has been propped up by the energy sector.
China slowdown
Concerns about falling economic activity in China were underscored by those poor macro pointers on Monday. Repeated lockdowns due to its zero-COVID policy have hampered growth in the world’s second largest economy. Chinese equities have been underperforming for quite a while now and led this year’s drop in global markets. Worryingly, we have seen renewed weakness in Chinese markets since the start of July, while markets in the west have rallied. If this year’s earlier sell-off is anything to go by, then dismiss the Chinese equity market weakness at your peril.
Europe’s energy crisis and hot inflation
While macro data has been quite mixed this week, the fact that inflation is still going very strong across Europe points to stagflation. We saw the UK CPI climb above 10% for the first time in 40 years, while a rather poor ZEW survey out of Germany was the latest to suggest the eurozone’s largest economy is in deep trouble as concerns grow about the impact of surging energy prices, which is squeezing households and businesses alike. There’s no end in sight to the energy crisis, which bodes ill for the already-struggling Germany and Eurozone economies.
US mixed data has divided opinion
In the US, mixed-bag economic data has divided opinion. With inflation remaining very high, coupled with a tight labor market and relatively strong equity markets, the Fed has not materially changed its hawkish rhetoric.
Indeed, FOMC member James Bullard has backed another 75-basis-point rate hike in September, saying the Fed “should continue to move expeditiously to a level of the policy rate that will put significant downward pressure on inflation.” In other words, Bullard—like most of his FOMC colleagues—wants the central banks to engineer a soft landing for the economy. But given how the Fed is always behind the curve, their aggressive approach may create a hard landing instead.
This is what worries some investors because we have seen certain sectors of the economy show serious signs of weakness. Among the weaker macro pointers that we have seen in recent days, there was another sharp drop in sales of existing homes, continuing its recent trend. Housing Starts also fell sharply. Meanwhile, the Empire Fed Manufacturing Index plunged sharply into the negative, as we found out on Monday. Consumer sentiment has been alarmingly low.
Following Bullard’s comments, market odds for 75bps rate hike in September jumped back to around 50% from 40%. However, underscoring how recent data has divided opinion, the once-big-hawk Kansas City Fed President Esther George, said the Fed had already “done a lot” in terms of tightening. She’s concerned that another large hike could do more damage than good. She said:
“I think the case for continuing to raise rates remains strong. The question of how fast that has to happen is something my colleagues and I will continue to debate, but I think the direction is pretty clear…We have done a lot, and I think we have to be very mindful that our policy decisions often operate on a lag. We have to watch carefully how that’s coming through.”
Has the tide turned?
While whether it will be 50 or 75 basis point hike will make a difference in the short run, the longer-term implication is that monetary policy is continuing to tighten, which is not supposed to be good news for a market spoilt by years of zero or near-zero interest rates and QE. Now the tide has turned. Fed has just started its balance sheet reduction process.
The question is has the tide also turned for the markets? Are we soon going to see the next, perhaps more profound, leg of the sell-off?
As concerns start to grow about the health of the world’s largest economy, we may well see the markets start to lose its appetite for risk assets, which obviously includes stocks. We’ve also seen a slump in Aussie dollar, iron ore and bond prices, all signs that suggest equity markets face a bumpy road ahead.
Thus, I can’t see why investors would be hungry to take excessive risk in this macro environment. It is becoming very difficult to justify maintaining an optimistic view on the stock markets at these levels.
Disclaimer: The author currently does not own any of the instruments mentioned in this article.