‘The Buy Signal Is Close To An End’

Is the rebound in risk assets sustainable?

That question burns after the Dow rallied into an ostensible bull market this week following Jerome Powell’s Brookings address.

That session’s gains pushed the S&P to within 15% of record highs, no small feat considering all that’s happened this year. The simple figure (below) suggests the stock drawdown is now fairly pedestrian.

Of course, that’s not the whole story. Not even close. When you consider the year stocks had alongside a historic drawdown in government bonds and the utter rout in IG corporate credit, 2022 will go down as a singularly terrible year, irrespective of what happens over the next three weeks.

We’ve seen this rally movie before, by the way. The summer rebound stalled when the S&P made it to within 10% of the highs. If you ask Goldman, the easing in financial conditions observed over the past month (on par with that seen in July and August) could be “self-defeating.”

For BofA, it’s probably too soon to get comfortable, even if it’s relatively easy to explain recent price action. “Peak inflation, peak China COVID, peak bond yields, peak US dollar = trough risk,” the bank’s Michael Hartnett remarked, writing in equations, as is his wont.

The Q4 rally is predicated on a very large pullback for the dollar, and a rebound in “oversold global cyclicals,” he added. The figure (below) illustrates the point.

Plainly, the fate of Hong Kong-listed Chinese shares rests entirely on the evolution of “COVID zero” on the Mainland. Suffice to say the situation is fluid.

As for the dollar, it was certainly due for a breather, but given dire economic straits in Europe, entrenched stagflation in the UK and the knife-edge nature of socioeconomic dynamics in China, it’s probably too soon to rule out another bout of dollar strength. That’s particularly true given the likelihood of recessions in economies where rate hikes threaten to torpedo housing bubbles. (Remember: America’s property boom looks tame when juxtaposed with the situation in Canada, Sweden, Australia and New Zealand, and most American homeowners are shielded from the impact of rate hikes by fixed-rate mortgages.)

Do note: Charting the dollar with equity indexes belies the scope of the greenback’s November decline. Last month was the worst month for the dollar in a dozen years. The Fed has at least another 100bps in the pipeline. And the US labor market, lagging indicator though it may be, is very reluctant to roll over, much like recalcitrant American consumers are loath to stop spending.

BofA’s Hartnett remains cautious, and it’s worth noting that after spending a very long time parked at 0.0, the bank’s pseudo-famous “Bull & Bear Indicator” just jumped to 2.0 from 1.4 the prior week (figures below).

“[That] means the ‘buy signal’ for risk assets is close to an end,” Hartnett said.

He went on to summarize the “2023 script.” The “inflation shock” is mostly complete, on BofA’s view. “Second derivative measures of inflation have rolled over,” Hartnett wrote, before suggesting that the “rates shock” for Wall Street is mostly done too. However, the rates shock for Main Street, and the accompanying “recession shock,” are “just beginning,” he said.

As for Q4’s market moves, Hartnett summarized the situation with an apocryphal quote from traders: “The Q4 rally is the same one everyone was waiting for in Q1.”