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US equity index debate - Are we to revisit the June lows?

Chris Weston
Head of Research
29 Aug 2022

After a 19% rally in the US500 and 24% in the NAS100 from the June lows, we are now testing the 50% retracement of the June-August rally.

The question that is being most heavily debated?Will we see the June index lows being re-tested and was the move just a bear market rally?

Talking to traders the list of concerns is vast and good news is hard to find. Here are a number of the key reasons worrying market participants and causing the sharp move lower.

  • Fed chair Jay Powell channelling his inner Paul Volker on Friday is hard for the market to absorb – it was purposely short and sharp – Powell’s speech was designed to shut off any possible dovish interpretation
  • While the US Aug CPI print (on 13 Sept) will be key if we get a big US payrolls print this Friday (consensus 300k) the market should firmly price the Fed to hike 75bp on 21 September and take expectations for the fed funds rate above 4% in 2023.
  • The Fed is now acknowledging that US households will have to go through some degree of economic hardship – a US recession (over the coming 12 months) is currently priced at 50% -I think this is fair but many will say this seems low.
  • The 19% rally in the US500 from the June lows was premised on a closing of bearish bets – given the rally we are firmly positioned more neutrally now – it seems the time to re-establish bearish bets and apply ‘cheap’ hedges are in play
  • The Fed are due to ramp up its balance sheet reduction program or Quantitative Tightening (QT) in September to $95b – this is the process of reducing its holdings of securities (US Treasuries and Mortgages) by $95b p/m – as with any typical accounting practice, a reduction is assets needs to be met with a reduction in liabilities – in this case, reserves. Statistically, we know US equity indices and Fed reserve liabilities have held an 80%+ 20-day rolling correlation
  • Month-end pension fund rebalancing flow – flow desks report a rebalancing out of equity and into bonds  
  • China remains weak (economically) and the UK/EU have a major energy crisis unfolding – EU Nat Gas prices aside, Gazprom close the Nord Stream 1 pipeline this week for maintenance – will it come back on?
  • The USD is breaking higher and is a wrecking ball for risk – the higher it goes the greater the risks to earnings and the global economy
  • US real rates (i.e. US treasury yields subtracting inflation expectations) are on the march higher, especially 2yr RRs – this is the real cost of capital, and it is moving sharply higher
  • S&P500 Consensus EPS for the FY is $226…this seems far too high
  • It all sounds quite dire – apologies – perhaps the best piece of news is that so many are turning bearish – still this dynamic favours weakness and lower levels.

Is sentiment too bearish again or are the buyers catching a falling knife – what’s your position?

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