Market Pulse: Recession is coming


The next inevitable recession represents a worrying scenario for governments and central banks: they must work very fine to get the countries out of this trap where they themselves led them.

Where is the market bottom?

This is the question that every retail trader wants to know the answer, because their portfolios, which were probably not properly protected during 2022H1, are gradually being destroyed in this bear market. All accustomed to the permanent bull market for more than 10 years ("stonks only go up"), stimulated by the easy money of the Fed, the dumb money, many of them young people who have never experienced a bear market, are desperate with this new panorama, different from everything before: this time the infallible "buy the dip" seems not to work as before.

Meanwhile, the smart money and institutionals, which do have the experience of distant bear markets and therefore have their portfolios duly protected with complex operations in options and other derivatives, are not so worried. That is why they continue to sell us, irresponsibly, the idea that after a disastrous semester, history says that the stock market recovery this second semester will be enormous and at the end of the year we will all be happy, with profitability in our favor "as is the norm." Nothing is further from reality. Moreover, there are indications that the market fall may be just beginning, because as long as retailers continue to buy, the capitulation of the market will not yet take place. And that's the moment when it will have reached its bottom and that will be the ideal place to buy that dip and also rearm the long portfolio

It's easy to recognize a market capitulation: all instruments (stocks, futures, bonds, cryptos, etc) crash in a few sessions, like in March 2020. In a practical way, gauge the market through the $VIX daily chart:  VIX mean-value (now at 20.8) plus 1 or 2 standard deviations (29 and 37) respectively, are usually reversal levels. But plus a third standard deviation (in statistics, the end of the Gauss bell, a very unlikely event), that's the VIX at level 46, indicates a market crash, panic time for traders, but also a unique buying opportunity.

A global recession is coming

Meanwhile, the economy (not only in the US but almost globally) is about to enter a recession. This is based on the basic theory of economic cycles (after the expansion and the boom comes the recession) confirmed by the successive weak growth results in indicators such as the ISM or GDP, and Consumer Confidence, among other studies. The first step, Powell already assured, will be to attack this high inflation with everything, which will only be defeated soon only if they continue in hawkish mode, with aggressive increases in the i-rate and supporting the QT, thus forcing a strong decrease of the demand, which will generate a strong recession in the long run, not the "soft-landing" as they want to sell us.

Initially, the recession will have a strong impact on the stock market, therefore, I insist, that the bottom is not even close yet. The next (Q2) earnings, one of the pillars of the stock market, will reflect this recessive economic cycle. And although there are already sectors such as commodities (crude oil, metals, food) and bonds (see below) that are perceiving that inflation just reach its peak after the last 0.75% rate hike, and are now correcting its prices, there is still a long way to go before the entire stock market fully discounts this fact. Remember, inflation is still above 8%!

The Fed will start with the rate cuts (2023Q2?) since inflation will no longer be a problem those days. And when that happens, the stock market, which anticipates everything, will begin to rise while the recession will continue, an apparent paradox, but not so for those who know the usual gap between the two as "the stock market isn't the economy".

Next Levels to watch

The key to a successful application of Price Action Trading is to choose the appropriate support and resistance levels and wait patiently for the price to approach or reach one of them to start making entry decisions. Let's review my technical levels for the next weeks in the key assets mentioned above.

Note. As a reference, in all my daily charts you will see as indicators: the RSI (in black lines its divergences), simple moving averages: DMA200 (wide light blue), DMA100 (blue), DMA50 (skinny light blue), and a quicker DMA20 (green). And the horizontal S/R levels, trendlines, and price patterns are drawn with different colors according to their term: short-term (ocher), mid-term less than 1 year (purple), more than 1 year (red), and long-term (black). Finally, the zones are in yellow. I always use different colors for a quick review at a glance.

1. SP500, close 3,813.5

The technical aspect only reflects the fundamentals and macro what was said above: the retailers continue buying the dips, but the SP500 does not find enough strength to overcome important resistance levels: in June it could not go beyond 4200, finally falling 6% in the month, in line with what was said in the previous Market Pulse.

Its bearish (ochre) channel structure is still appropriate only for swing trades, especially sell highs, in the range between 3650 and 3950, its last swings, all in the short term. Further down, critical levels await, such as 3600, support for the (purple) downtrend line and the Fibonacci 50%, at 3500, an interesting level to think about rebuilding part of a long portfolio of stocks and bonds. In summary, continue the strong bearish bias in the SP500.

2. 10-y T-Bond, close 2.89%

Judging by the 10-year T-Bond behavior in its weekly chart, above, it appears that the market is beginning to price in the fact that inflation has peaked and may start to decline. This is the only way to explain the strong pullback in its benchmark $TNX

And by lowering its yield, the price of the bonds rises, making them attractive to slowly accumulate shares at the psychological 2.5% level, because finally in the long-term it is a safe bet, given that inflation will, sooner or later, redeem to its target 2%. Let us remember that bonds have had the worst fall in their history this 2022H1, and on the other hand it is unlikely that the yield will go beyond 3.7% or 4% since it would make unmanageable the giant world debt. A global monetary catastrophe that would topple everything, world markets included. For these reasons, it's so important to follow this yield chart and wait for the inflation data in the middle of the month, decisive for the future of the economy.

Technically the price action (a big bearish engulfing candle in the mid-June high of its daily chart, not shown) and RSI divergence worked efficiently and has been driving the yield value towards the 2.7% level, its Q2 support, where it will surely find a lot of fight and a probable short-term rebound. I don't see it even in the short term reaching now levels of 2.3% or 2%, maybe by the end of the year.

3. Invesco DB Commodities Index, close $26.77

Commodities, the sector with the best behavior during 2022H1 (understood due to the rise in inflation that increases its demand and with it, its price), finally began to feel great pressure after its parabolic rise, and the market made it known through a nearly 10% pullback of its $DBC ETF in just two weeks. The unknown is to know what will happen now. And the answer may be in the US dollar and its next behavior.

Remember, a strong dollar will always be a problem for a commodity, given that these are always traded with that currency, while a weak dollar is usually a stimulus for exporters and therefore for commodities. And the dollar is still strong, and surely it will be with the next Fed i-rate plan. This inverse behavior dollar/commodities added to the probable decrease in inflation, mentioned above, opens up an interesting niche for short trading the last.

Technically, the RSI divergence worked well and today price is fighting against its (blue) DMA100 after losing the (light blue) DMA50. Losing that support goes straight to its Fibonacci 23.6% at $25.88. If the price can't stand it, it will reach the key $24, which is the great uptrend line from its COVID lows and also the powerful DMA200, a place for trading decisions.

Good trading,

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