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Investing With Recession Fears Looming, Are We Nearing Market Bottom?

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Based on the 12-months Google Trends searches, recession is a very hot topic in the market. The search peaked in mid-June 2022, but has been showing some decline lately.

This could be the result of the recent market shift where the equities market have shown signs of recovery just several days before the end of June, whereas the commodities market showing broader declines. The decline in commodities market potentially signaling the inflation’s peak, and that is a good sign for the equities market.

But one needs to also understand that the diminishing demand for commodities also tell us the economic activities is slowing down as well.

1. US Equity Drawdowns And Recoveries

The S&P 500 index has entered bearish territory but has surfaced from that territory on 24th June 2022. Referring to the above chart, the declines or the drawdowns of the US equity is not as bad as it was in the 1957-1959 and not as devastating as it was during the start of the pandemic in 2020. The recovery made during the post-pandemic years was swift and strong, recording a 142% gain. It shows how resilient the US equity market back then when faced with crisis and uncertainty.

But the question is, will it be the same this time when there’s higher inflation, supply chain crisis and geopolitical tensions? To have a simple answer to those questions, we can refer to the Average VIX index – an index that tell us on the market’s fears.

2. Fear Index (VIX)

Referring to the Average VIX chart above, we can see how the fear index is closing in to the recent market drawdowns that knocks down many businesses & industries globally. Year 2022 (YTD) is the fifth year where the average VIX reading was among the highest since 1990. And during this time the equity market showed potential signs of recovery from market bottom with the lowest VIX reading compared with the other highest VIX reading in history.

Will this be the sign of hope most of us look for? The unit trusts market have been hit hard recently, with almost no hope for decent returns to fight against inflation.

3. Presidential Election Cycle

We need to take several other factors into consideration in order to clear from the market fog or market noise. First we need to understand what market cycle we are currently in. Most will point out that we are in the VUCA (Volatility, Uncertainty, Complexity, Ambiguity) market. But if we look more closely by studying the market cycles, we are currently in the “Mid-Term Presidential” which affects the US markets and the global markets in general.

Based on the historical market cycle patterns, the Mid-Term Presidential cycle is very volatile, with indecisive market movements. We have experienced this indecisive market direction since the start of the year. The market direction could give us some hope of positive gain but it quickly fades away. June normally is the weaker month for the equities market and may spill over to other equities markets outside the US.

Market recovery could potentially happen towards the end of the Mid-Term Presidential cycles and continue its ascend move during the Pre-Election Presidential cycles as depicted from the chart above.

Past studies since 1990 also shows that Bursa Malaysia’s market direction has a positive correlation with the market movement in the US. Therefore, we can also use Dow Jones market movement as the benchmark on Bursa’s potential market direction.

4. Equity Fund Flows

The second factor that we need to observe is the equity fund flows during market corrections. An interesting data provided by EPFR, Haver and Deutsche Bank Asset Allocation depicts that the fund flow into the equity market has been positive and robust this year.

We might be asking what may be the positive reasons behind that move? It could be from contrarian beliefs. Normally the contrarian will move in the opposite direction of the market direction or beliefs. AAII (The American Association of Individual Investors) is the best source for the contrarian market studies and beliefs.

5. No More Bears?

Based on the recent data and chart of AAII provided by Bloomberg, the bearish sentiment reading has hit an all-time high since the 2008 Global Financial Crisis (GFC). Normally with the bearish sentiment reading hitting this high of a level, it will tend to bounce back down and signal a market bottom. Or in layman’s terms, the start of market recovery.

6. Solid Corporate Earnings

Next we can refer to corporate earnings, which could be the third data to support potential market recovery from recession. Data from JP Morgan below shows just how resilient the corporate earnings during major market correction. All major equity indices from Europe, Japan and the US show positive corporate earnings despite experiencing heavy market drawdowns.

7. China’s Comeback

The Chinese market on the other hand is also showing recovery after facing lockdown in all major
cities. It has disrupted the global supply chains to date, but with the new economic stimulus
package unveiled recently by President Xi Jinping could potentially boost supply chain recovery
and help in the global economic growth over the years.

A chart provided by Bespoke provided a key fact that the market recovery has happened in China
through the KWEB (KraneShares China Internet ETF). KWEB has outperformed the SPY (S&P
500 ETF) by a considerable margin (-11.9% vs. -20.8%). Since late May, KWEB has gained
29.7% compared to a decline of 4.5% for SPY.

Will recession just briefly come to us in 2022? Is it time to start shopping in the equity markets?

With all the facts from the previous data and charts, we can approach the equity markets carefully without rushing to buy any stocks that’s making any bounce from the bottom. Listen to the music that the market is playing. We will start to add more stocks buying when the markets continue to make new highs or progressively moving higher from the market drawdowns.

8. Attractive Share Price

A quick look into the 5 largest stocks in the S&P 500 as depicted by the chart above, none have any forward P/Es above where they were in 2020. However, to date all of them still have a positive EPS for next year, again showing resilient in negative market environments.

Some of them have even shown a decent bounce from their 2020 lows, particularly Amazon and Meta Platforms (FB) depicted by the chart below. All other stocks are able to sustain above the lows at the start of 2021.

Source: https://www.tradingview.com/x/wD8nBgam/

About the Author:

Mukhriz Mangsor, ACSI, CFTe, MSTA, FPPP has nearly two decades of experience in financial investment and trading. His clients include financial education, financial institution and prop trading firms in Brunei, Canada, Malaysia, Singapore and the US. He is currently Head of Global Market Strategist at Quantdynamic Research Company and can be contacted at mukhriz@quantdynamic.com.

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