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Get Ready for the Bear Market

Last week’s selloff was brutal for investors in the US stock market: the Dow Jones Industrial Average closed at its lowest level since late 2020, falling to 29590.41, losing 1.6% on Friday alone. With the S&P 500 currently down a whopping 23% from January’s highs this year, and other indexes close behind percentagewise, stock market bulls are understandably desperate to find any event to warrant optimism. Unfortunately, despite some respite from US inflation in July and August, there does not appear to be much reason to expect this selloff to stop anytime soon. With bearish momentum emerging for equities, and fears about an impending crash and recession growing, we have no choice but to get ready for the bear market.

What is a Bear Market?

Technically speaking, there is no strict definition for a bear market, since it is a more colloquial term than an exact set of financial conditions. However, it is generally agreed upon that when analysts refer to a bear market, they are discussing a financial market or index that has lost at least 20% of its value from recent highs. It is also worth noting that a bear market can occur without that market crashing, since a crash often refers to a dire situation in which said market loses at least 10% of its value in a single day.

Why is This Happening?

Many factors can contribute to a bear market, ranging from trade and foreign policy issues, to market-generated financial crises, to fiscal and monetary policy. In this particular situation, there appear to be two interrelated key catalysts creating a looming bear market in the United States:

1) An extremely hawkish Federal Reserve that is in eager pursuit of contractionary monetary policy, with economic growth being sacrificed accordingly. Chair Powell recently emphasized this at the FOMC press conference by explaining that for now, the Fed can only fulfill its ‘dual mandate’ by focusing on stabilizing prices at the expense of high employment, for the sake of eventual maximum employment. Stocks are not just a casualty in the effort to reduce high prices, they are a primary target.

2) Poor economic forecasts for both businesses and consumers, tied together in a vicious cycle. High interest rates will make it difficult for businesses to borrow or attract investors, as their high-risk shares and bonds will be far less lucrative compared to low-risk alternative securities. This nearly guarantees that they will have less capital to spend on employees, reducing employment opportunities and triggering layoffs for workers who are already struggling under the weight of high inflation and costly debts. These workers will then likewise spend even less, guaranteeing lower revenues for businesses accordingly, further impeding growth.

How Severe Will It Be?

For better or for worse, because of how unpredictable markets are by nature, we are effectively unable to know just how severe this bear market and recession could be. However, between the Federal Reserve’s far-from-spotless track record (2022’s hawkish Powell is, in fact, still the same person as 2021’s dovish optimist who dismissed inflation as ‘transient’), as well as the inherent lags in inflationary data such as Core CPI, the Federal Reserve could easily overshoot their tightening effort and create a depression.

This seems especially possible considering how badly the stock market has been hit while the labor market remains hot; these selloffs may become far worse as unemployment rates begin to increase, particularly if high global food and energy prices remain a problem for US consumers. However, because this hawkish monetary policy mission is consciously created by the Fed, rather than being the result of a structural failure as per the Financial Crisis of 2008, there is a chance that a meaningful economic recovery could be implemented more quickly than in decades past.

What Can Be Done?

Sadly, little can be done by working people to prevent a bear market from occurring beyond a miraculous, coordinated effort to voluntarily reduce consumer spending across the United States. Even if volatile food and energy prices continue to fall in a similar fashion as over the last few months, the Fed would still likely keep their eye on core inflation for a more complete picture. This downturn is being induced at an institutional level and is ostensibly unavoidable.

Nonetheless, for those who are long-term investors, bear markets also present myriad buying opportunities, as many shares across sectors are available at heavily discounted prices. For those who are patient and have some income to spare, building a diversified portfolio through recurring investments in safe, reputable funds remains a simple way to capitalize on poorly performing indices. While these methods by no means cancel out the horrors of economic suffering, value investing in this fashion offers consumers some semblance of wealth-building agency as we endure this business cycle.

Key Takeaways

• There have been significant declines in stock market prices since January of this year, with some indices, like the S&P 500, losing over 20% of their value. These trends sadly don’t appear to be stopping.
• A bear market is a term typically used in the context of a financial market or index that has lost at least 20% of its value from recent highs.
• While bear markets can occur for numerous reasons, the primary catalysts behind an impending bear market in the US appear to be hawkish aggression from the Federal Reserve and a bleak outlook for businesses, workers, and consumers accordingly.
• Although the exact dimensions of an anticipated bear market are unpredictable, it seems plausible that its severity could exceed that of current FOMC economic projections, though perhaps last more briefly because it is only artificially induced by the Fed.
• Unfortunately for working people, little will likely be done to prevent this downturn from happening at an institutional level. However, for those who can set aside some money for recurring and diversified long-term investments, buying opportunities will be plentiful.

Why the New FOMC Decision Matters

Yesterday, the Federal Open Market Committee (FOMC), the Federal Reserve’s policy-making body, implemented yet another 75 basis point interest rate hike. While this move was perfectly in line with market forecasts, Chair Powell’s comments following the subsequent press conference, in which he discussed the FOMC’s new set of economic projections, were significant. He continued to emphasize the Fed’s commitment to bringing year-over-year inflation back down to 2%, even at the expense of short-term economic growth, offering little in the way of dovishness. These events may become key fundamental catalysts for further bullish USD price action and stock selloffs, hence why the new FOMC decision matters.

Top Pairs to Trade

Because the Federal Reserve has re-upped its commitment to contractionary monetary policy, which is favorable for the US Dollar’s value in the forex market, USD bulls have ever more reason for fundamentals to be on their side. The following pairs are among the EdgeFinder’s top recommendations for USD bulls, as can be seen with their respective ratings and biases/signals. The first three pairs have either broken through or just touched support, with potential breakouts to the downside seeming plausible. The fourth pair, USD/JPY, sold off today before finding some support, while even more buying pressure seems likely in light of the Bank of Japan's decision yesterday to continue their ultraloose monetary policy.

1) EUR/USD (Receives a -7, or ‘Strong Sell’ Signal)

Why the New FOMC Decision Matters
Why the New FOMC Decision Matters

2) GBP/USD (Receives a -6, or ‘Strong Sell’ Signal)

Why the New FOMC Decision Matters
Why the New FOMC Decision Matters

3) AUD/USD (Receives a -4, or ‘Sell’ Signal)

Why the New FOMC Decision Matters
Why the New FOMC Decision Matters

4) USD/JPY (Receives a 4, or ‘Buy’ Signal)

Why the New FOMC Decision Matters
Why the New FOMC Decision Matters
Has Everything Changed for Major Pairs?

This week the public received startling news: on Wednesday morning, month-over-month CPI (a proxy for inflation) in the United States had unexpectedly remained static, clocking in at 0% whereas a moderate 0.2% increase had been forecast. Core CPI (which excludes food and energy prices) likewise came in lower than anticipated at 0.3% month-over-month, while Thursday saw the Producer Price Index surprisingly decline 0.5% month-over-month. This prompted a mass selloff of USD across major pairs on Wednesday and Thursday, with the US Dollar Index (DXY) temporarily plummeting by 1.8% from the start of the week while stock indices soared. While demand for USD has recovered a bit since, with the DXY now down only 0.87% from Sunday, it is worth asking: has everything changed for major pairs?

Argument A: The Bearish Case for USD

A 0% month-over-month inflation rate may signal that the worst of price increases is finally over in the US. Annual inflation might have peaked, and consumers can breathe a sigh of relief now that three key events have occurred: 1) energy prices have dropped significantly due to a dip in demand, while US natural gas storage and oil barrel inventories also exceed expectations. 2) The Federal Reserve has embraced monetary policy hawkishness, and their rapid 50-75 bp rate hikes have worked, successfully restricting borrowing and thus curbing demand. 3) Despite a tight labor market, the US unemployment rate consistently hovers around 3.5%, granting a subtle degree of price stability.

Argument B: The Bullish Case for USD

Unfortunately, despite 0% month-over-month inflation being a welcome respite from high inflation, this one piece of data does not capture the full economic picture. Here are three reasons to expect high inflation to continue in the US: 1) though having fallen, energy prices could likely remain volatile and high because underlying global energy supply problems (e.g., mutual sanctions on Russian exports, OPEC’s unreliable output, energy dependence) have not been resolved. 2) Considering the scale of monetary stimulus over the course of the pandemic, and the double-digit federal funds rate that was historically implemented to stamp out high inflation, it would be shocking if these past few rate hikes were enough for the Fed to bring 40-year highs to an end. 3) The hot labor market may cause wages to further play catch-up, contributing to core inflation.

My Bias: Bullish (With a Grain of Salt)

Despite this particular cooling CPI report, I am retaining my bullish bias on USD, though admittedly with less confidence than before. The international and domestic economic conditions at work do not appear to have changed in a significant fashion as consumers still grapple with the consequences of an unprecedented money supply, labor shortages, and energy instability. However, if US inflation data continues to fall behind market expectations, I will certainly reassess this bias.

Best Pairs to Trade

According to the EdgeFinder, A1 Trading’s market scanner that helps traders conduct economic and sentiment analysis, here are two optimal pairs to trade for USD bulls: 1) GBP/USD, which has a score of -7, earning a ‘strong sell’ signal; and 2) USD/TRY, which has a score of 4, earning a ‘buy’ signal.

Last Friday, the US reported NFP numbers that came out much stronger than expected. This event further green-lit the Fed's path to send rates higher and topple inflation. Usually, jobs growth is good for the economy and the stock market. But, here is why it could also make the recession worse.

Bad For Business

When you see an incredible beat in jobs expectations, you probably wouldn't think about being in a recession. These two events are not correlated in a positive manner. However, it could be bad for companies in the long run.

Higher interest rates makes it harder for businesses to borrow, spend and hire new employees. NFP showed signs of a recovering economy from a really good month of job growth. If the Fed continues to be this aggressive (by 75 basis points), we will likely see businesses struggle.

What To Look For

This Wednesday's CPI report will tell us a lot about the market.

recession
USD CPI m/m

What investors are waiting on is a drop in consumer prices which haven't really been able to slow for a long period of time. CPI has gotten much worse over the span of one year. Consistent decline would be promising for the markets going forward, but we would need to see that in order to turn bullish.

recession
CPI expectations for Wednesday

Analysts heavily expect a drop in inflation this month. That paired with substantial job growth could turn the market positive and form a more bullish bias around stocks. The Fed still sees inflation way out of reach for now, but anything can happen as we wait for Wednesday's numbers to come out.

Index Setups

SPX500

recession

SPX500 rises premarket after a decent last week of earnings and job growth. Price is nearing resistance at a double top on the 1D timeframe which could uphold as strong supply. That level is also right below the 61.8% fib retracement level which could serve as another tough level to break above.

NAS100

recession

The NAS100 looks to have hit a strong falling trend line on the 1D. Price is already showing rejection on the day with a large rejection from the highs. The inverted hammer suggests a start of a deeper sell off to come. Support lies right below, however, around $12,935.

UK100

recession

The British index shows a less exciting day for stock trading after price pulled back from daily highs and is starting to look like the NAS100. Price might have started to turn downward, however, there is still room for the index to run and hit resistance at a double top around $7658.

4 Ways Housing Bubbles Affect Forex

Throughout much of the developed world, housing prices have recently begun taking a tumble. Home valuations and rent costs had soared to unsettling high levels amid near-zero interest rates and other pandemic-era monetary stimulus; however, near-ubiquitous central bank rate hikes are beginning to bring many countries’ housing prices back down to earth. According to the Economist, in Sweden, home prices declined by almost 4% in June, while in New Zealand they have depreciated from highs for three consecutive months. Considering that real estate remains the biggest asset class in existence, and that housing markets arguably lie at the heart of global economic output, forex traders would be wise to consider these fundamentals when buying or selling pairs. Let’s explore 4 ways housing bubbles affect forex, as well as other markets.  

1) Measures Inflation Rates

For foreign exchange traders, gauging inflation within a currency’s host country is practically essential to fundamental analysis, since it often correlates with economic growth and helps analysts anticipate potential interest rate hikes. While there are many useful measurements of inflation, such as the Consumer Price Index (CPI) and core Personal Consumption Expenditures price index (PCE), measurements like the House Price Index (HPI) and home sales data are also relevant.

This is because higher housing prices and increased home sales are signs of a hot housing market, which indicates higher levels of consumer demand and thus potential inflation. After all, if house prices are increasing, this is typically because more people have money to spend on purchasing a home, whether through income or borrowing. This presupposes that they have general access to financing that they could use elsewhere, driving up prices in other industries too. Therefore, keeping up with the latest housing market data can be handy when it comes to assessing the severity of existing inflation.

2) Influences the Cost of Living

Besides offering data regarding pre-existing inflationary threats and spending patterns, housing market data can also give traders insight into how home prices transform the cost of living. For example, in the US in 2020, according to the Bureau of Labor Statistics, average housing expenditures were over $21,000 per ‘consumer unit’ and accounted for over one third of all consumer spending. This means that the cost of renting a home or taking out a mortgage has serious implications for the overall cost of living.

While rising home prices in general may not contribute to high levels of inflation, this past year’s sky-high prices are not ordinary circumstances: they are symptomatic of a bubble (when prices are far higher than they fundamentally ought to be), created artificially through low-interest loans. When central banks around the world incentivized easy borrowing through low rates and quantitative easing, they encouraged consumers to take out cheap, fixed rate mortgages and other debts while still spending more elsewhere, for the sake of economic stimulus. However, this short-term solution may have disturbing long-term consequences, as high inflation persists globally while rate hikes now abound in response.

3) Guarantees Revenue for Banks

Because commercial banks have multiple revenue streams that include owning mortgages and selling mortgage-backed securities, they have become instrumental to housing market activity. Due to acutely limited supply across many countries’ housing markets (for example, by some estimates, England is over 150,000 new homes behind in construction per year), many home buyers would not be able to afford the purchase without substantial loans from these banks.

However, ‘money-printing’-induced housing bubbles have further bolstered the banking industries via the housing market, and vice versa. When central banks encouraged bountiful lending, spending, and investing, increasing the number of homebuyers, this meant more clients for banks than would have otherwise existed, often including the central banks themselves.

By propping up the banking industries through these new borrowers and asset purchasing programs, this influx of capital also enabled banks to further profit from new investments, exacerbating inflation in a top-down manner due to the artificial, allocated capital. This is because, in many countries, commercial banks can also legally operate as investment banks, generating higher returns on investment by engaging in more risk. For example, this has been the case in the US since the overturning of Glass–Steagall in 1999.

4) Promotes Fragility, Not Stability

Between the recessions created by the 2008 financial crisis and today’s recessions caused by high inflation rates around the world, recent history offers a compelling case: housing bubbles promote economic fragility by accelerating expansion and contraction (i.e., boom and bust cycles). Unfortunately, for now, it appears that this lesson may have been learned too late, as the world’s central banks embark on a mission to crush consumer demand as a sort of necessary evil by venturing deeper into recessions in search of price stability. However, traders can learn to read housing bubble data accordingly, recognizing it for what it is: indications of severe overheating, followed by indications of impending contraction.

Key Takeaways

As global equities rise as central banks continue to stay hawkish on curbing inflation numbers. However, some things have led to risk appetite which we will discuss as well as what could happen due to this rally in stocks. Here is what we think might happen and why you should not be fooled by an event like this.

Fed's Tone

The Fed decided to raise rates by another 0.75% which has brought interest rates from 1.75% to 2.50%. However, investors took the FOMC statements as less hawkish than expected. This was due to the fact that Powell mentioned the possibility of loosening up on quantitative tightening.

As output slows, economists can argue that a recession is already happening. And with each contractionary month, we can start to see a pattern here. This is probably why Powell talks about getting more dovish. Although these hikes won't stop, the Fed still plans on increasing rates but with less aggression.

fooled
US inflation index

For example, the 75 basis point hikes might shift to 25-50 over time. But this would have to depend on where inflation goes. So far, there is no sign of stopping as the inflation index reached 9.1% from 8.6%. That marked the hardest move since February.

Market Drivers

fooled
GDP growth rate in the US

This table shows us the GDP growth rate in the US each quarter. Since January, output has slowed and even showed decline. We are seeing minor improvements in the growth rate, but there is still quarterly declines.

Output and inflation are some of the market's biggest movers. Investors need to see that things are improving so that they can start investing again. Fears of another sell off coming still loom, but people who have been cash heavy are also worried that they could be missing out of the next bull market.

Analysts are arguing two sides of the coin, so it's unclear where to turn to. By looking solely at the fundamental metrics of the US economy, it's pretty clear that they are very much not out of the woods yet.

With that said, here are some setups to upside and downside and which levels are going to be deciders in market direction.

Trade Setups

SPX500

On the 1D timeframe, price has already broken above resistance at $4070 and is working its way up towards the $4200s. A key bullish flag would be if we saw another higher low and high on this timeframe as well as a break in the $4200s level. A bearish indicator would be if we saw rejection on either level of resistance and a test at support around $3920.

There is also resistance in the 61.8% fib zone that could pair with the previous top to push price lower. Several supply levels wait above the current price, so the index will probably struggle to move higher should the rally continue.

New BRICS Currency Vs USD

What Is BRICS?

The acronym BRICS refers to an economic alliance between multiple powerful emerging economies, including Brazil, Russia, India, China, and South Africa, respectively. Altogether, they currently generate over 25% of the world’s GDP, and are home to over 40% of the global population. While BRICS membership does not necessarily entail exclusive trade perks or benefits, they value geopolitical cooperation with one another, meeting at annual summits since 2009.

How Are They Challenging USD?

Many analysts interpret BRICS as being a response to the West’s expanding geopolitical influence via NATO and the G7, one that grows ever more significant following the invasion of Ukraine. This function is particularly evident given that Russian President Vladimir Putin recently proposed in June that BRICS develop an "international reserve currency based on the basket of currencies of our countries" to rival the US Dollar. If enacted, this could mean the end of an era for USD hegemony on the world stage.

How Serious Are Their Intentions?

China is reportedly aiding in this new reserve currency endeavor, as Western sanctions against Russia pile up while other BRICS countries fear similar treatment. China’s President Xi Jinping has accused the US and its allies of constructing “a small yard with high fences” via economic warfare. This international sentiment is apparently not unique: thus far, five more countries have either applied or plan on applying to join BRICS, including Iran, Argentina, Saudi Arabia, Turkey, and Egypt, with many more countries formally invited. This interest is especially significant in light of the existing tensions between these countries, such as China and India, Iran and Saudi Arabia, etc.

How Could This Affect Major Pairs?

If such an alternative reserve currency is enacted, and subsequently denominates many international trade transactions as the BRICS alliance grows, the foreign exchange market could see a big drop in demand for USD against other currencies. This could also herald the end of the petrodollar since many BRICS countries are prominent oil and gas exporters. Although these ambitious plans will likely not be realized for some time, this could eventually mean a huge paradigm shift for major pair fundamentals.

Tomorrow, the FOMC outlook will give investors a gauge on what could come next for the US economy and USD. This news will be followed up with the new interest rate which is expected to go up by another 75 basis points. Here are the best pairs to trade before we get the news.

EUR/USD

best pairs

EURUSD caught support as price fell to the downside and touched a lower low on the 1H timeframe. There is a chance for upside, but the rally has not been very promising or strong in a sustainable way. If price does see more of a rally, it could touch 1.02700s before retracing. However, it looks like price wants to continue to the downside after breaking under support in the 1.01300s.

Gold

best pairs

Gold struggles to get out of the support zone as long setups have only been working for quick and volatile moves upward before retracing back to new lows. Price still has support around the $1670s but could also come up to test the falling trend line on the 1D timeframe or resistance in the $1780s. An interest hike could take the metal lower, so price may come down to the second price target.

USD/JPY

best pairs

USDJPY hit a key support level on a rising trend line on the 4H timeframe. Price bounced from that level and has formed higher lows from there. Should price continue to steadily climb, there is resistance above at 137.500 and close to 139.

SPX500

best pairs

Stocks retrace on big tech earnings anticipation and even the recession-proof stocks like Walmart on a cut in profit outlook. Some support lies about 10 points below current price and cleaner support sits below that around $3744. Signs of the bear market rally being over might have started, and we may return to the lows of $3640 or lower.

AUD/USD

best pairs

AUDUSD could be trying to go higher towards resistance around 0.70455 on the 1D timeframe. Price could also retrace from the current resistance level on the falling trend line with support below at 0.68301 and a previous bottom at 0.66821.

Why the Stock Market Rally Is a Mirage

US stock market bulls experienced a month of respite as major indices have rebounded from their mid-June lows over the following five weeks. The Dow Jones Industrial Average crossed above 31,800 on July 19th after finding support upon dipping below 30,000 in June, and the S&P 500 likewise nearly hit the 4000 level on July 20th after having touched 3650 in June. Even with mixed earnings reports and a surprise 50 basis point rate hike from the European Central Bank seemingly prompting US stocks to take a tumble intraday on Thursday, July 21, investors were treated to another ultimately positive day as indices closed higher. However, despite over a month’s worth of restored buying pressure, this recent indices-wide leap is likely not as optimistic as it seems. Let’s explore fundamentals as we discuss why the stock market rally is a mirage, as well as what investors could expect timeline-wise.

Why the Stock Market Rally Is a Mirage

USD Trade Complications

Although a soaring USD in the foreign exchange market enables American consumers to indulge in lower priced imported goods, the flip side is that it comes at a cost for many US businesses. For those corporations that have historically sold goods and services internationally, these prices overseas are now far higher than in years past, limiting foreign demand. Thus, a highly valued USD makes US exports (approximately 13% of US GDP) less enticing for trade partners, which can substantially limit revenue for these businesses in the US, disincentivizing potential investors by theoretically limiting their earnings and share prices. Considering that USD looks primed to continue its bullish trajectory into the near future, this could be bad news for US indices overall, and by extension GDP growth as well.

Why the Stock Market Rally Is a Mirage

Ill-Fated Consumer Demand

As is the case in every market or mixed economy, corporate earnings in the US are predicated on demand for the products and services that companies are selling. High inflation is happening in America because, as in much of the world, demand for products and services has significantly outpaced their supply; this has resulted in today’s uncomfortably high prices and a hot labor market, bolstering corporate profits to a degree.

However, this strong demand is quite unlikely to remain. Factors such as US employees’ wages and salaries failing to rise at the rate of inflation (with average hourly earnings having increased only 5.1% over the past 12 months, compared to 9.1% inflation), as well as a hawkish Federal Reserve intent on aggressively cooling the economy through raising interest rates, will impair consumer spending. This will mean less income for US businesses by extension, as well as far less money spent buying stocks speculatively as in recent years.

Why the Stock Market Rally Is a Mirage

Global Economic Conditions

Although the US economy is currently the largest economy in the world in terms of its $25 trillion GDP and vast net wealth, much of this growth has been due to its relationship with the global economy. By relying heavily on free trade agreements, as well as foreign direct and portfolio investment, markets in the US have been transformed by globalized supply chains and reinforced by an ongoing influx of new capital.

While this approach to prosperity ostensibly comes with benefits, such as cheap imported goods and huge financing possibilities, it also comes with liabilities, such as those we are encountering today. Globalized supply chains aren’t conducive to flourishing if the world’s economies are in a tailspin while supply is unusually limited. Likewise, US businesses can’t rely on buying pressure from foreign investors if these investors have less capital to work with themselves. Thus, the US stock market is in double jeopardy, as it must endure both global and domestic economic hardships.

Why the Stock Market Rally Is a Mirage

No More Deus Ex Machina Fed

The Federal Reserve, the central bank for the United States, has established a unique role for itself over the past fifteen years as the lender of last resort. During the financial crisis of 2008, as well as the pandemic-induced crash in 2020, the Federal Reserve undertook unprecedented measures to save the US economy through monetary stimulus. By implementing quantitative easing as well as low interest rates to escape recession via emergency expansion, the Fed made history by being willing to spend its way out of any economic crisis, stabilizing markets and causing stocks to rapidly appreciate in value.

However, with potential for recession and stagflation around the corner in the US economy, the Fed’s ability to play monetary savior is now severely restricted. With annual inflation over 9%, at 40-year highs, the Federal Reserve is forced to confront hyperinflation threats, even at the expense of consumers and businesses. The Fed won’t be able to rescue the markets with its usual dovish tricks because this time the contraction is of their own making, as a sort of necessary evil. This is incredibly bearish for US indices, because there will likely be no multi-trillion-dollar last-ditch effort to prop up corporate share prices this time.

Why the Stock Market Rally Is a Mirage

How Long Will This Last?

Unfortunately, it appears that both the US’ and the global battles against high inflation are just beginning. With the Federal Funds Rate currently hovering around 1.75% as inflation surpasses market forecasts, and the Federal Reserve reportedly considering a full 1% rate hike with many more hikes left to go, US indices are seemingly destined for a prolonged bear market. While it is virtually impossible to know when the stock market will hit bottom, with much disappointment for short-term bulls likely ahead, long-term investors can take heart, knowing that this can also mean myriad discounted buying opportunities over the next few years.

Key Takeaways

Warning: Stock Market Looking Bleak

This morning US investors were greeted to yet another unwelcome, though perhaps not unexpected, decline in the stock market. At the time of writing, the Dow Jones Industrial Average has slid over 300 points today, or over 1%, after recovering slightly from dropping over 500 points earlier this morning. The Nasdaq and S&P 500 have likewise dropped over 1% intraday. While these events are disappointing in themselves, they are part of a recent disturbing downtrend of significant proportions, including a brief dip into bear market territory and the worst performing first half for the S&P 500 in fifty years. Unfortunately, there only appear to be several possible paths forward, with none of them favorable to stock market bulls. Let’s explore what this means for traders and investors as we issue a warning: stock market looking bleak.

Path #1: Selloff by Further Rate Hikes

One likely possibility for the US economy is that the Federal Reserve continues implementing further rate hikes to curb hyperinflation. This seems quite plausible for three reasons: a) high inflation in the US has thus far persisted, with the most recent CPI data for May reflecting a 1% increase in inflation month-over-month, and an 8.6% increase year-over-year; b) historically, high inflation seems likely to continue, considering cooling the similarly overheated US economy forty years ago required double-digit target interest rates; c) Jerome Powell, Chair of the Federal Reserve, has already signaled that the Fed is willing to continue rate hikes as necessary, perhaps even resorting to more 75 basis point ones if needed.

If this comes to fruition, it would likely be bearish for the stock market since the Fed’s past several aggressive moves have ultimately prompted increased selling pressure for stocks. The Fed’s hawkishness particularly affects the stock market because its recent highs were due in large part to COVID-era dovish monetary policy, which shareholders ostensibly can’t rely on anymore.

Path #2: Selloff by Impending Recession

Another plausible possibility for the US economy is that it continues its descent into full-blown recession. Such features include recurring contractions in gross domestic product, higher unemployment rates, and lower consumer spending from the lack of work or decent income. This would likewise be a disaster for the stock market, since its performance is often interpreted as, and anticipated to be, a proxy for the health of the US economy. Low consumer spending equates to less money spent purchasing goods and services from businesses, as well as dwindling confidence and spare capital from potential buyers, sending share prices lower and forcing even more layoffs.

While a recession can theoretically cause low inflation via lower demand, and thus no more need for further interest rate hikes, the stock market would nonetheless be caught in the crossfire. While many economists anticipate recession being likely, if not imminent, even the Federal Reserve acknowledges the risks as they forecast higher unemployment and slower economic growth as unfortunate sacrifices for having stopped hyperinflation via contractionary monetary policy. The US stock market would thus be a central casualty if a recession is induced.

Path #3: Selloff by Stagflation

One particularly disturbing possibility for the US economy is the chance of stagflation, a nightmarish fusion of both recession and hyperinflation. This would entail most aspects of both paths 1 and 2 playing out simultaneously: economic activity would contract as consumers and businesses lose money in a vicious cycle, while prices remain unusually high, exacerbating the effects of recession. This unfortunately seems possible in the US because of how current global supply chain bottlenecks are contributing to inflation by restricting supply, causing the price of oil and other commodities to soar. Thus, there is a significant chance that this tragic phenomenon could occur, which would be doubly disastrous for the stock market.

The Bad News

Unfortunately, it is difficult to imagine a probable scenario in which the US stock market doesn’t plunge deeper into selling pressure. Continued bearishness over the next few years seems incredibly likely regardless of what exact problems deal these next few blows to the US economy. Thus, for any traders who are short-term stock market bulls, please know that the chances of a prolonged, near-future rally for equities seem slim. The US is no outlier, either; the global economy is currently afflicted with these same issues. We will have to weather this economic storm altogether.

Some Good News

However, for those who are long-term investors, any stock market selloffs can be understood as optimal buying opportunities. This is because the US economy, like other market or mixed economies, experiences business cycles: periods of expansion, followed by contraction, rinse and repeat. Due to the US’ abundance of natural resources, huge population, international influence, and more, the US economy is incredibly resilient and able to rebound from recession long-term.

This means that even if fundamentals don’t currently look good for the stock market, they are still promising through the decades, which net favors long-term shareholders and bulls. So long as investors stick to a thoroughly diversified portfolio, investing regularly in historically reliable funds such as index funds and other trustworthy ETFs, and abstain from premature selling due to worries and disappointment, bear markets present bargains for future wealth building.

Key Takeaways

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