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Is a sustained market bounce realistic?

Posted by: Brian Dennehy
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It is the US market I am thinking about here, as to a large extent the UK will follow – though the risk of a Brexit bombshell remains, which we will cover again in the next fortnight.
 
As regular readers already know, our analysis informs us to expect a new uptrend, which will take out the peak of last October, once this current correction is complete. Last week I also highlighted two alternative, positive, paths for the US market, albeit ones which our framework for analysis suggests as less likely, at least for now – see the chart at the end showing these possibilities. [As an aside, for those whose optimistic gene is stirring, please don’t forget the main alternative which we always highlighted from this time last year. That would mean we are midst the early stage of a much sharper downturn, with falls of 50%+. Just saying.]
 
In any of these three eventualities there would be a new uptrend, and a new peak. Until last week you might have been scratching your head wondering where the impetus for that might come from, and we planned to answer that question this week. But some of the wind was taken out of our sails on Wednesday with news from the Federal Reserve – though not all the wind, so let’s explore that.
 
In the latest TopFunds Guide we highlighted that it is confidence which is at the centre of market and economic trends – simple enough, yet many tie themselves in knots with rules and equations and graphs and make it much more complicated.
 
In the last month or so we presented evidence of confidence slipping away. For example, housing data surprised to the downside at a rate that exceeded that in 2008 and 2009. And we argued that without evasive action this would get worse in 2019 as the sugar rush from Trump tax cuts and regulatory reforms wore off.
 
Importantly, confidence in the US stock market changed rapidly in the Autumn. Trump gets that the stock market is a barometer of the likelihood of his re-election. If he wants re-election in a little less than 2 years, what can he do to stop the rot in the stock market, and provide the vroom to boost confidence sufficient to fuel the uptrend to new highs and his re-election? 
 
It appears that he can no longer pull the tax cut rabbit out of the hat, as a Democrat-controlled House of Representatives would not allow that.
 
Would making up with China do it? It doesn’t feel weighty enough. Plus any short term tariff truce must be seen in the context of what is a multi-decade rumbling conflict as the US rankles at the new boy on the block flexing its muscles, and not playing by the (U.S.) rules.
 
A foreign adventure is always a strong possibility. It’s an age-old tactic. When you are losing popularity at home, engineer a conflict, ideally in someone else’s country. The theory is that your country will unite behind you. It feels like a long shot to spur the market.
 
Iran seems the most likely target, but there are two problems which Trump might over-look midst declaring war on Twitter. The first is of a huge shock to the global economy from rocketing oil prices such as occurred in the 1970s. Second is a cyber attack by Iran and its allies (Russia?) as we wrote about in June 2018.
 
Surprisingly little discussed, a further possibility is simply that he takes the initiative and resigns, and everything bounces. The ultimate Trump surprise.
 
Lastly, and more likely, the Federal Reserve might inadvertently aid the Trump re-election campaign.
 
Back in the January 2018 edition of our TopFunds Guide our clear view was that the Fed was putting interest rates up not because they were worried about inflation – as most headlines would have had us believe. They were putting rates up because they believed that when the next economic downturn was upon us rates needed to be higher, so that cutting them would have a meaningful impact – they didn’t say that, but the implication was clear at the time (particularly in the absence of inflationary pressures to justify their action).
 
They started raising interest rates in December 2015 from the emergency rates close to zero, and have since raised nine times, though only gradually and 2.25% in total. They had created a bubble – perhaps several bubbles – and they wanted to let the air out gradually, without a big pop – for which there was no precedent.
 
In December it appeared that the Fed was set to continue on this path of “normalisation” in 2019, and whingeing in some quarters led Michael Lewitt (thecreditstrategist.com) to say:
 
“I find calls from media types and others that the Fed should stop raising rates and rescue the stock market once again a sign of intellectual and moral weakness that typifies why our society is incapable of dealing with any serious problems”
 
Strong words from Michael, but ones with which many will sympathise. He also said of the current head of the Federal Reserve, Jerome Powell, that he:
 
“Does not appear to be afraid of markets falling and isn’t going to be cowed by President Trump’s ill-advised remarks about interest rates.”
 
But that was before Christmas. It has all changed as of last Wednesday: 
 
“The Federal Reserve executed a sharp about-turn on Wednesday as it put further interest rate rises on hold” (FT)
 
Was Powell under political pressure from Trump? Has he been seduced by the need to protect markets just like his predecessors all the way back to Greenspan in 1987? (On which see “The Awaited Policy Error? It’s behind you…”) 
 
The response of the US market on the day was to go up 1.5%. According to The Guardian headline this was a “surge” – the reality is that it was a run of the mill market move.
 
On the following day (yesterday, 31st January) all eyes were on Washington as Trump said the negotiations with China will result in “the biggest deal ever”.
 
Big positive news? The US market as measured by the Dow Jones index fell a touch, while the S&P 500 went up a bit more. In terms of market reaction it was a bit of a yawn.
 
We shouldn’t read too much into just those two days, and the markets more considered reaction over the next two weeks will add clarity on whether sufficient confidence has been restored – as President Trump would like.
 
Last but not least it is worth re-stating that our framework for analysis merely helps us build one central picture of the future. As a minimum this helps us manage our expectation and keeps us on our guard, particularly when various indicators are at extremes. We also visualise alternatives which appear less likely but for which we must nonetheless be prepared – this mental preparation is very important. Finally, do read this week’s Guest Blog on the folly of forecasting.
 
Chart 1
Topic: Market commentary


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