This is now the biggest problem of the stock market – How long can the illusion last?


The summer stock market “weather window”

This year’s rather negative sentiment and performance in the stock market has left a strong mark on the various sentiment surveys in the eight months that have passed so far. Such extreme pessimism often raged for weeks, which at other times marked significant market bottoms and was the “birthplace” of a galloping bull market. This year, however, it very much seems to be this kind of negative investor attitude was only enough for a significant rise in the bear market:

In the summer months, the bear market rally from roughly the 200-week moving average to roughly the 200-day moving average arrived:

And then came the black soup at the central bank symposium held in the usual summer resort village of Jackson Hole on Friday, August 26, where This year, Fed President Jerome Powell has repeatedly sobered up the investor community that believes in the transience of the processes taking place in the world. (Of course, we can remember that, last summer, Powell was one of the main promoters of transitoriness in relation to inflation.)

Different forms of illusion

No matter how pessimistic the sentiment surveys are, it seems to me that on certain issues the investor community is still incredibly optimistic, and many people think that the global economic downturn from the late spring of 2021 will only last for a short time, and then good times will come again.

I call this mentality the illusion of transience.

The illusion of transience has been with us for almost a year and a half now. At first, the capital market believed that inflation above five percent was temporary, then came the belief in the temporary nature of the Russian-Ukrainian war and its effects. Then, as a result of stricter-than-expected Fed communication and actions, the market already began to price that some kind of recession must come, but still preferring to think that it will just be a bit of a recession: quick, not too severe and transient. And it’s not that bad, at least it makes the amazing tension of the labor market temporary. (The US labor market data published at the beginning of August do not show this yet.)

And finally, one of the biggest stock market beliefs in the year 2022 is (was?) that the Fed’s so-called monetary tightening will only be temporary. (The so-called word refers here to monetary strictness, the Fed’s base interest rate is 2.25-2.5 percent in addition to the latest inflation data of 8.5 percent.) The combined mention of the (retrospective) minus 6 percent real yield and strictness is at least as interesting as those market expectations, which have appeared several times this year, according to which interest rate cuts could come as early as 2023. As if in economic history it was ever enough to fight 8-9 percent inflation with an interest rate of 3 percent.

And the destruction of illusions

If we take a look at the S&P 500 index with daily candles between October 1, 2021 and August 29, 2022, we can see three significant events that have scalded the US stock market, rocking itself in the illusion of transience:

These three events, indicated by the numbered blue rectangles, were:

  • First scalding (April 21): Mentioning the name of Fed President Paul Volcker, who reigned between 1979 and 1987, implemented the antithesis of the era of money printing between 2009 and 2021, and raised interest rates sky high in the fight against inflation, as an example to be followed.
  • Second scalding (June 10): Publication of inflation data for May – which surprisingly rose to another 41-year high.
  • Third scald (August 26): Jerome Powell’s speech in Jackson Hole, already mentioned at the beginning of the article, predicting a much stricter monetary policy than the market expected.

The first two events brought about a substantial fall, the impact of the third is still not sufficiently visible after two trading days.

Nvidia as a corporate illusion case

There is one area of ​​the broad American stock market where we have seen less of the impact of deteriorating economic processes, and that is corporate efficiency in the general sense. However, this does not mean that in individual cases we do not already see dramatically deteriorating sales revenue, profit and margin images. An excellent example of this deterioration was the case of Nvidia from the month of August. The company, which currently still has a stock market capitalization of 395 billion dollars (which makes Nvidia the 12th largest US stock market company), had its quarterly sales from the first quarter of 2017 to the second quarter of this year as follows:

Nvidia’s price chart with daily candles showed this between May 2 and August 29, 2022:

The August 8 warning (blue rectangle marked with the number 1) said that the $8.3 billion sales expected by the market in the August 24 flash report will only be $6.7 billion. Then on August 24th (blue rectangle marked with the number 2), along with the report came a warning for the next quarter by lowering the expected sales of $6.7 billion to $5.9 billion. The reaction to these two announcements was rather mild compared to their weight. Then came the day of the green arrow marked with the number 3, with Powell’s speech, when they poured 9 percent on the stock. This was already a lot for Nvidia shareholders who believe in a temporary worsening of conditions.

The biggest problem with the stock market

The illusory phenomena just presented are the reasons why I cannot (yet) believe that we are nearing the end of the sharp stock market fall that started between November last year and January this year. My personal experience so far with markets that have fallen heavily, like the current one, is that the end of the trend reversal and the bear market always arrived in an extremely bad investor mood. At a time when the vast majority of the investing community thought that everything had gone wrong here once and for all. Not that the various deteriorations and their effects are only temporary…

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