It has been and continues to be a volatile environment for financial markets as it has become increasingly challenging to determine if this market environment can change.
Are the mid-Oct 2022 lows in for the year, or will markets experience new lows?
The better question is whether the Fed can engineer a soft or hard landing in 2023.
We turn to the financial markets to determine the state of the US economy.
On the equities front, investors remain risk-averse and are defensive in their equity positioning, focusing heavily on large-cap defensive and value-related names and sectors.
Dow Jones Industrial Average (INDU), consumer staples, utilities, and healthcare sectors outperform their peers. Other indexes such as S&P 500 Index (SPX), Nasdaq Composite Index (COMPQ), Nasdaq 100 Index (NDX), S&P 400 Mid-Cap Index (MID), and S&P 600 Small-Cap Index (SML) may be recovering near term, but are currently trading below their respective 200-week moving averages and primary downtrends.
If the broader-based indexes cannot reverse above their critical resistances, this does not bode well for the sustainability of the 10/13/22 rallies and warns of the potential for a hard landing next year.
In the commodities arena, geopolitical tensions in Russia-Ukraine and China have created a volatile commodities market environment. The question regarding whether OPEC will cut or raise oil production remains unclear.
The CRB Index (CRB – 2755.52) peaked in early-Jun 2022 (329.59) as the benchmark commodities index has struggled to regain its long-term uptrend. A bearish death cross-sells signal in Oct 2022 and failure of CRB to surpass the 200-day ma (291.14) warns of a potential top.
WTIC crude (WTIC – 78.20) has also suffered a setback after peaking in Mar 2022 (130.50). WTIC must surge convincingly above initial resistance in the mid-80s (50-day ma) and preferably surpass pivotal secondary resistance in the mid-to-high 90s (Oct/Nov 2022 highs and the 200-day ma) to improve.
Falling commodity prices suggest inflation pressures may not be a problem, as many feared. A continued decline in commodity prices warns of increased risk for a recession in 2023.
On the fixed income side, the yield curve has inverted along the short end of the curve. However, it remains relatively flat in the long end, creating confusion about the direction of long-term rates. Historically, when the yield curve inverts on the short end while flattening on the long end is an early sign of an impending recession.
Fed controls the short end of the curve via the Fed Funds rate. The long end conveys the future outlook of the US economy. The direction of the benchmark 10-year Treasury yield (TNX) will often offer guidance as to the US economy.
TNX continues to test key support at 3.48-3.56%. Violation here hints at a decline toward intermediate-term support at 3.05% (200-day ma). Below this reverses the primary 1-year uptrend and opens the door for a subsequent decline to 2.5-2.75%, increasing the risk for a recession and possibly a hard landing.
On the other hand, above 3.898% (50-day ma) warns at a retest of the crucial resistance at 4.33-4.5% (Oct 2022 high and the top of the 2-year uptrend channel. A breakout reinforces the call for higher interest rates and higher inflation.
There have been five SPX declines of -12.37% to -19.28% and five advances spanning +8.83% to 18.93%. The fluctuations on either side of the market have confused and frustrated investors. The financial markets remain quite volatile and will likely stay like this into the end of the year and early next year.
We recommend traders and investors closely monitor the conditions of SPX, CRB, and TNX for guidance as to whether the US economy is indeed moving toward a soft or hard landing next year.