Virtually overnight, as the economic recession spread across the globe from Asia and Europe to the U.S. and even Russia, global stock indexes took a serious nosedive. Instantly, as the economic downturn spread into the U.S. and Europe, global financial markets swung dramatically to a risk off position, with global stock exchanges experiencing major violent sell-offs, steep price reductions and even surrendering multi year support levels for equities in most potential for a downwards trend in U.S. and European stock indexes. While, on a macro level, this is good news for investors who have been riding the wave of a prolonged global economic slowdown that has been building since late 2021, on a micro level the moves are unnerving for individual traders. In particular, this trend is particularly unnerving for those who have been gaining global equity exposure over the past several years through either fundamental or technical moves or movements in stock indices.
One of the first indicators that we began to see across global stock indexes was the “dead cat bounce” – when momentum increased suddenly in early April and quickly accelerated away from that momentum, ultimately culminating in a sudden, sharp drop. This happened to be the first time that we had seen this type of quick reversal in a large reversal trend (such as the move from the October 2021 lows to the June 2021 highs). Typically, most market reversals take a long time to develop and gain meaningful momentum (which can take six months or more) before reversing themselves completely. With the global financial crisis happening in such a short period of time, it was incredibly difficult to accurately gauge how far the markets would fall before they reversed again (with the data being extremely thin for the U.S. and Europe). While it was still relatively early in the day, the global markets were in freefall – and it was only a matter of minutes before the momentum of the late April swing reversed once again.
As we moved into May and looked at the global stock indexes, we began to see some signs that the momentum of the late April low had tapered off. In addition, we began to see signs of price divergence across stock indices. As with the global financial crisis, the early months of the year typically offer the best trading conditions. The first two weeks of May typically offer the best retracement levels (as prices near the moving averages), which means that traders can take advantage of the best potentials for price divergence.
Now, let’s take a look at what can happen in a normal market in terms of market retracement and divergence. Assuming that the markets continue to operate in accordance with fundamentals, a strong case can be made that the late spring/early summer market should experience a number of bear markets before there is a return to uptrend continuation. This would likely occur just prior to the second half of the year (which is generally considered to be the ideal time to enter the market and obtain optimal profit levels). However, it’s not impossible that the late spring/early summer could experience a number of consecutive bear markets before a reversal in the market occurs. This would be the perfect time to purchase if you are expecting a sustained period of gains.
During our study of global stock indexes, we found that there tends to be a high degree of correlation between equity markets and the United States Federal Reserve. Correlation is the tendency for one market to tend to move strongly with another. Because the United States Federal Reserve is so directly associated with the health of the economy, it is often used as a proxy for other economic indicators, such as unemployment rates, consumer sentiment, and general business conditions. Unfortunately, correlation doesn’t prove causation; however, it does show a significant relationship between these indicators. In this sense, correlations between equity markets and the Fed may reveal an underlying trend for future performance.
In terms of price/correction, the late spring and early summer are potentially a strong replacement opportunity. If the United States Federal Reserve raises interest rates, global stock indexes will likely experience a surge. Similarly, if the Fed is expected to reduce interest rates, the markets may contract. It’s important to remember, though, that although central bank interventions can help a market out of recession, they can also cause substantial long term damage.
Our economic recovery study found that there is a low to medium level of correlation between major global stock averages and two of the most important economic indicators, inflation and unemployment. With this information in hand, it’s possible that the U.S. Federal Reserve may move to raise interest rates before its planned schedule in the 2021 calendar year. If so, stock indexes will begin to retrace the path of the Fed’s planned actions. Moreover, the tightening cycle will likely continue into the second half of the decade, extending the damage of the recession even further.
Are investors concerned about a U.S. Federal Reserve rate increase before it even begins to take effect? Historically, it has taken the third quarter of a calendar year for the Federal Reserve to hike interest rates. If it takes place during the second half of this year, that means that it will be much harder for investors to react quickly to the Fed’s move and take advantage of the negative impact of the hike. On a positive note, the two factors that we consider most bullish on the outlook for the markets are unemployment and inflation. The weak job market has forced many companies to lay-off their workforce. Consequently, global stock averages are showing signs of strength due to lower unemployment figures, a slower economy and higher consumer confidence.