Dow on edge of bear market, recession fears rise, GBPUSD guidance fears for financial stability


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

  • The market outlook: USDJPY bearish below 141.50; Gold bearish below 1,680
  • After the FOMC rate decision was absorbed last week, risk aversion began to ramp up, shrouding perpetual fundamental risks
  • Market conditions are once again my primary concern heading into the new trading week, with liquidity and seasonal norms threatening to catalyze serious fundamental and technical risks

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Dow: Risk Aversion Turning into Fundamental and Seasonal Problems

The FOMC rate decision last week was a significant event as the world’s largest central bank again significantly tightened financial conditions and reinforced the fact that inflation takes precedence over economic expansion at short term and on any market crisis. However, I believe its simple overshoot opened the market up to the exceptional volatility we’ve been experiencing recently. There have been persistent systemic fundamental threats that we have conveniently ignored for months, allowing sentiment to drift unbound to traditional speculative appetite motivations. Yet without a fundamental event to temporarily distract us from dealing with the backdrop we are dealing with, it has been easier for the fires to spread. Among the most interesting risk indices for me heading into next week, I’m raising the so-called Dow “blue chip” index to the top of my threat radar. This index goes by the moniker “value index” and it was very noticeably successful in avoiding a technical “bear market” during the sell-off until June – when the S&P 500 snagged the ignominious designation. Last Friday, the Dow Jones came exceptionally close to earning its own scarlet letter, but barely escaped it at the close. If that step is taken in the coming week, the flood of headlines alone will prove a burden.

Chart of the Dow Jones Industrial Average with 20 and 100 day SMA (daily)

Chart created on Tradingview platform

Still, whether or not the Dow Jones joins its larger peers in pulling back more than 20% from its all-time highs, there are strong winds that speculative interests are heading towards. On the technical side, multi-year and decadal lows are hitting financial and capital market assets, leading to fear of volatility, if not outright risk aversion worry. Fundamentally, the overlapping issues of relentless inflation, rapid monetary policy tightening, and an unsettling proximity to a call for global recession represent a backdrop in which a simple “bear market” simply does not reflect not the current problem. 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 present. Still, there are ups and downs around this average. More consistent as a “force of nature” and less of a consequence of current headlines is the level of volume and volatility (“participation” and “fear”) that is happening right now. On this front, we face troubling seas.

Chart S&P 500 Monthly performance, volume and volatility averaged from 1980 to present


Graphic created by John Kicklighter

S&P 500 and VIX: Pain Scale Projection

I am convinced that market conditions are more important than the traditional fundamental and technical influences on which we usually focus our analysis. Whether or not the markets are deep or shallow, fickle or stoic, can dramatically alter the impact of a scheduled data release or technical milestone break. That said, we’re entering the last week of September – again what turned out to be the worst month of the year on average for the ‘risk’ benchmark – and we’re already down – 6.6% with volume and volatility far from peaks. Looking at a more detailed picture of the historical performance of the S&P 500, the 39th week of the year stands out. It averaged the worst index drop of the calendar year. Should he repeat this performance? Absolutely not. That said, the backdrop is decidedly unflattering for this round in 2022.

S&P 500 Chart Average Weekly Historical Performance 1900-Present


Graphic created by John Kicklighter

As large and significant as the market pullback has been in recent weeks, it is still not a complete deleveraging of risk exposure. There are two general paths that markets follow when analyzing changes in broader trends. The most practical development is that the fundamentals are reversing globally and the markets have a solid basis for a recovery. That said, such change is slow and overdone across the backdrop; and we see few “green shoots” as the pacing and projections seem to deteriorate. Alternatively, an entirely speculative “flush” can occur during panics, leading to what is often referred to as “surrender” (although usually after the fact). This is a scenario where the market quickly and completely discounts the forecast so that the opportunists are willing to step in and take the risk that the end is near or imminent. Although VIX volatility hit a three-month high at the end of last week, it looks far from true color. Although it is relative, I look at the 50 level of the volatility index as a general threshold.

VIX Volatility Index Chart with 100 Week SMA (Weekly)


Chart created on the Tradingview platform

GBPUSD the best fundamental lightning rod and backdrop that can amplify the mundane

As we enter the new trading week, I will definitely be keeping an eye on the Dow Jones, S&P 500 and VIX; but the foreign exchange market may well offer a more complete reflection of our financial situation than anything else. The incredible burden of the US dollar is shifting from focus of carry to territory of fundamental burden for investors and watchers alike. The greenback pushed the EURUSD off its peg at parity (1.0000) with a clouded outlook for the Eurozone economy taking over. The USDJPY is perhaps one of my favorite pairs to watch for fundamental information as policy makers (the Ministry of Finance in Japan) attempt to fight market undercurrents by simply following the disparity in the parameters of Monetary Policy. Still, GBPUSD is the first place I will look in the forex market in the coming week. The “cable” completely collapsed to close last week. Last Friday’s -3.6% drop was one of the worst days for the pair in a decade. Only the peak of the pandemic, Brexit and the Great Financial Crisis have seen worse. Monetary policy differentials matter less here, with growth disparity a more important consideration as the BOE warned that the UK could already be in recession. Yet it was the reaction to the new Prime Minister and Chancellor of the Exchequer’s growth agenda that seemed to push him over the edge. If there are questions surrounding London’s financial stability (relatively), the dollar is in a good position to take advantage.

Chart of GBPUSD with 20 and 200 day SMA, 1 day ROC and 20 day disparity index (daily)


Chart created on Tradingview Platform

Looking at event risk over the coming week, the potential for quote impact is modified by the changing mood of the market. The economic and financial fallout from external influences and central bank commitments will amplify the significance of the various updates. Tangible economic milestones need to be watched more closely. The IMF is due to release an interim economic outlook on Monday that is about as comprehensive as it gets. However, the Chinese and Japanese September PMIs, the US Consumer Confidence Report and the European Economic Sentiment Surveys are key listings. I will also ensure the commitment of the various major central banks to ward off the threat of financial instability. There is a long line of speakers from the Fed, 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 again be watched to see if she can clarify the confusing message from the group trying to catch up. And, when it comes to Bank of England members on tap, the pound’s collapse and recession warnings will demand a response.

Risk of a critical macro event on the global economic calendar for next week


Calendar created by John Kicklighter

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