Sideways Market Movement, Experts Disagree

Chart of the Week

The chart shows the total inflows and outflows into equities (light blue line) and corporate bonds (dark blue line) since January 2020.

Why This Matters

Since the beginning of the year, investors have been withdrawing substantial amounts of money from corporate bonds. Markets have declined accordingly.

The picture is different in equity markets. Although they have also lost significant value, there have been only limited outflows. At first glance, this may seem surprising. However, it suggests that large institutional investors with substantial assets have not sold so far. They have increased their cash holdings by selling bonds, but have not yet reinvested that money. If even part of it flows back into equities rather than bonds, it could provide a strong boost to stock markets.

Sideways Market Movement, Experts Divided

The market moved sideways last week amid high volatility. It is rare for political analysts and economic experts to be as divided as they are at present.

On one hand, the war in Ukraine is escalating. After years, NATO has officially identified Russia as an enemy, and Putin is deploying nuclear-capable weapons to Belarus. On the other hand, some experts, such as former U.S. Secretary of State Henry Kissinger, believe that Putin may soon achieve his war objectives and could offer a ceasefire within the coming weeks.

Although the war continues unabated, oil prices are falling and wheat prices are collapsing. The market is surprised to find that since the beginning of the war, there has actually been more oil and wheat available on the market than before the war. This once again highlights how important it is to look at the data and not be driven by panic in the media. We also repeatedly warned against investing further in oil or wheat.

Economic forecasts are also more divided than usual. Some experts believe a recession has been avoided. Supply chains are recovering, and consumer spending is slowing only moderately. Others see union demands for higher wages as the beginning of an upward inflation spiral that has only just started. This camp includes respected specialists such as Ray Dalio and Jeremy Grantham. Then there is the arch-pessimist Michael Burry, who believes markets could fall another 50%.

Michael Burry famously predicted the subprime crisis and became wealthy as a result. In the movie The Big Short, actor Christian Bale plays his role. Burry’s argument is that central banks will not be able to reverse the massive expansion of the money supply during the COVID crisis without triggering a total economic collapse.

We do not share these extremely pessimistic views, but we remain cautious regarding further economic developments. We still see an upward market rebound as the most likely scenario over the coming months. In addition to the fundamental reasons we have outlined in previous market reports, positive signals from technical analysis are also emerging.

Technical Market Analysis Confirms Potential Market Recovery.

Technical market analysis aims to use appropriate indicators to identify trends in price movements that are difficult to detect with the naked eye, helping investors make better investment decisions. It is also designed to make recurring mass-psychological behavior patterns easier to recognize and identify at an early stage. Here is a current example:

The chart shows the price development of the S&P 500, the broad market index in the U.S., since January 2020. The line at the bottom of the chart is the MACD index. The index shows the divergence between different moving averages. A detailed definition of the indicator can be found here. The indicator can be used as either a trend-following or trend-reversal signal. Normally, the indicator moves in line with price action. This means new highs in price are accompanied by new highs in the MACD (as seen, for example, at points 1 and 2).

However, when divergences occur, they are typically a strong signal of a trend reversal. For example, the new high in the price of the S&P 500 at the beginning of the year (point 3) was not confirmed by a higher high in the MACD compared to point 2.

The same principle works in the opposite direction. Between points 4 and 5, the market declined, but the MACD moved higher. This was followed by a strong rebound.

A clear divergence is currently forming again between points 6 and 7. New lows in the index price are not being confirmed by the MACD, which is showing higher readings instead. As was the case after points 4 and 5, a rebound now appears more likely than a further market decline.

Many experts view the predictive value of technical analysis as no better than reading tea leaves. For the long-term positioning of client portfolios, we rely on fundamental analysis. However, for short-term timing, technical analysis has often served us well. For example, at point 6, we re-entered the market with only small positions and only significantly reduced cash holdings in client portfolios at point 7.

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Disclaimer:

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