Disclaimer:
Nothing contained in the following content constitutes an offer, solicitation, or recommendation regarding any investment management product or service, or the offer to sell or the solicitation of an offer to buy any security; The following content is purely for information only and is based on information available at the time it was created. It does not take your financial situation or goals into consideration, and may not be suited for you.
Things take longer to happen than you thought they would, and they happen faster than you thought they could. The market shows significant sign of exhuastion, it may be time to hedging downside risks. For large drawdown, we may still need a catalyst.
Since December 2022, large-cap tech stocks have outperformed the market and pushed the stock market upwards. This has contributed to the strong performance of QQQ. However, concerns about stagflation and macroeconomic realities haven't yet been reflected in markets. Investors have been betting on a Fed capitulation, easing inflation, a mild recession, debt ceiling removal, China reopening, normalization of US-China bilateral relations, reduced tension in the Middle East, normalization of supply chain bottlenecks, an end to the war between Ukraine and Russia, and guaranteed peace at the first island chain. The list goes on.
Macroeconomic Reality
There are some realities we must currently face.
a) Firstly, US bipartisan efforts are still focused on China-bashing. Once a global consensus is formed, it will be difficult to change course. This has been and will continue to worsen as elections in European countries, the US, and Canada are all, to some extent, leveraged on China-bashing narratives. As a result, the recovery of the situation may be way slower than the market expects.
b) Inflation remains sticky, and demand is recovering slower than expected. We are experiencing slow growth and it is particularly concerning when people reduce their spending on consumer staples. The European Central Bank is planning another hike in the coming months. If inflation remains sticky, the Fed may become more resolute to follow. This can be a downside risk to watch out for the US market.
c) The problem of the debt ceiling and loan defaults in commercial real estate could be alarming in the coming months. Default rates on loans for both Chinese and US homeowners have steadily risen over the past month. As property prices continue to be under pressure, restructuring can be difficult for companies and mortgage servicing is becoming increasingly difficult for many individuals.
It is reasonable to believe that some spending on consumer discretionary and staple items has been moderately reduced to accommodate mortgage repayments amid an uncertain economic outlook. If the Index of Economic Activity continues to trend lower for these categories in the coming months, default risks could increase drastically. At some point in time, there will be no more room to squeeze.
Technicals and Mechanics
There is substantial inconsistency within the market. QQQ and FANG have outperformed the market, while equal-weight QQQE, RSP, IWM, SP500, and Dows have all been weak. For a price time series to be sustainable, we need to see synchronicity across all underpinning data streams. It’s like diagnosing a patient - you can’t be in good health if you have lung cancer, even if your heart, liver, and brain are all functioning well.
Currenly, the entire frenzy in the market has been largely driven by large-cap tech stocks. When synchronicity across markets is low, it indicates fundamental weakness and fractures within the market. Therefore, it is reasonable to conclude that the current growth for large-cap tech is unsustainable.
The ADX is currently at a very low level indicating that a major move is around the corner. Given the exhaustion and sell setup we see on daily and weekly charts, there is an increasing downside risk for QQQ. SP500 and Dows have already tipped into downward trend momentum on their daily charts. How the three indices will synchronize at this point in time will determine the direction of the market in the near future.
When interest rates are low, and credit is easy to come by, there’s a high chance that exhaustion will continue. This is because people can always roll over their debts, and the outlook for both corporations and individuals is promising. Plus, there’s plenty of money available in the market. So once exhaustion has been moderately fixed, the temptation for FOMO kicks in and brings technicals back into exhaustion territory. That’s part of the reason why trending models and mean reversion perform well in low-volatility markets.
But when credit isn’t readily available, there’s no fuel for continued exhaustion. The market tops out when the last buyer buys and bottoms out when the last seller sells. Since QQQ is showing strong exhaustion, it’s unlikely that its momentum has enough upside to bring the other two indices into the technical territory they need to be in. But we cannot rule out the sideway move to fix such synchronization problems. If this happens on the weekly chart, we may revert to the past thesis, which is trending toward the third quarter of this year. But current risk leans towards the downside.
Dollar
The dollar has been quite oversold, but USDCNY remains at a very high level. At some point in the future, this inconsistency will realign, and when it does, we expect the smaller basket to follow the larger basket. If this situation plays out, it could add another layer of downside risk to the supply chain and macroeconomic situation. However, it is unclear how assertively PBoC will react to such a situation or their ability to do so, given that their current foreign reserve is hovering around 2010 levels. How PBoC reacts to such a situation determines the outlook for the market. As a market participant, nobody knows what their reaction will be given the complexity of the current geopolitical and economic landscape.
The current worry of the US dollar losing its reserve currency status is unfounded. There was a chance CNY could gradually be accepted and form the trinity, not the reserve currency, with Dollar and Euro if the 2002 - 2008 momentum continued. Now it is delusional at least in the near or mid-term future.
Things take longer to happen than you thought they would, and they happen faster than you thought they could. For a long time, investors have emphasized the positive and ignored the negative. If things are ambiguous, they interpret them as positive. This reciprocal cycle of positivity has fueled investors’ enthusiasm for large tech stocks. We may still need a catalyst for large drawdowns. But the downside risk is increasing at the current point in time. Currently, it may be time to start hedging for downside risk, though the depth of the drop remains uncertain.
Disclaimer:
Nothing contained in the following content constitutes an offer, solicitation, or recommendation regarding any investment management product or service, or the offer to sell or the solicitation of an offer to buy any security; The following content is purely for information only and is based on information available at the time it was created. It does not take your financial situation or goals into consideration, and may not be suited for you.
