Seven Days Ahead offer financial and commodity market forecasting, technical trading analysis, forex forecasting service, stock market trading recommendations, guides and strategies in the UK.Sign up now

The Uncertainty of Stocks

22 May 2008

The Uncertainty of Stocks

The Macro Trader’s view:
Since mid-March equities have enjoyed a strong rally, started by the rescue of Bear Sterns, which for many marked the beginning of the end of the credit crisis.

The Fed eased policy again during their scheduled March and April meetings in response to continuing economic weakness, but there were already murmurs in the markets that inflation required more attention, so equity traders turned their attention to what they saw as the coming recovery.

With many leading US Banks and investment Banks readily raising fresh capital, to plug their sub-prime losses, the stage seemed set for a quick return to business as usual. Moreover, data at the end of April into May turned firmer and the Fed was judged to have concluded its easing cycle.

Indeed, this week’s FOMC minutes have confirmed this, revealing that policy-makers will only ease again if the growth outlook materially weakens from what they currently expect.

But at the beginning of this week equities dived as US PPI came in worse than expected and the Oil price made new highs right down the strip, plus Gold extended its recovery.

The implications for growth are clear: if oil continues to rally inflation will spike higher yet and growth will turn negative. The reality is for the first time in over twenty-five years the leading economies face stagflation.

But will oil rally as high as some fear? If it doesn’t then inflation will moderate and although slower growth would still occur, recession might be avoided.

This then, is the uncertainty faced by stocks: is inflation about to explode and growth collapse, or will slowing growth ease oil prices sufficiently to stabilise growth?

One thing is for sure, the Central Banks are caught in a tight corner:

1. Unable to hike interest rates for fear of pushing their economies over the edge into recession, and
2. Unable to ease sufficiently, or in the case of the ECB; at all, for fear of unleashing a bout of inflation that would ultimately prove painful to ring out of the system.

In short, policy makers can now only sit tight, cross their fingers and watch.

The Fed has slashed rates as far as they think safe; the Bank of England has eased policy lower and, while further tweaking is likely, they are sending out a message to suggest there is no more room for manoeuvure. The ECB swings from sounding hawkish over inflation, implying a hike is imminent, to briefing that growth could slow dramatically this year.

But while stocks are mired in uncertainty, we think there is a clear trade that offered much better risk return: betting on rising bond yields in this environment. Timing is as ever tricky, but we are already short from better levels in our Key Trades Portfolio.

As inflation threatens to spike investors will increasingly demand higher premiums to compensate for the erosion of inflation, and as growth slows and government deficits widen due to a reduced tax take, bonds will confirm what we have long thought: they are a bear market.

The Technical Trader’s view:

The S&P market is very well structured with clear levels to trade around. But the arguments for bull and bear positions are finely balanced....for the moment:

The market is at a critical juncture.

The failure at the 1153 Prior High from 1999 was an important one – a second failure at a level over a long period of time has enormous bear potential...

All the more so if there is a nicely completed Top formation such as that which drove the market down at the end of 2007.

But bears should note well that the minimum target for that completed Head and Shoulders Top was met.

So the rally back to the Neckline has been altogether more robust than a simple short-covering.

Nonetheless, the failure at the Neckline over the last three days is an important failure for the bulls. Unless prior lows can be smashed, the bear trend remains in place....look closer.

But for all that medium-term gloom, the short-term bulls will point out the solid H&S bull structure beneath the Neckline.

They won’t lose heart short-term unless the bull Head and Shoulders Neckline at 1387 is broken....

And even if that is broken, they will point out the robust bull implication of the Double Bounce from the 1268 level.

Only if that 1268 level were to be broken would they abandon the medium-term bull case.

Mark Sturdy
John Lewis
Seven Days Ahead

[For the complete and illustrated version of this and future Updates be sure to sign up at]

Receive three Market Updates fully-illustrated with charts each week for one month FREE

Next story:
Oil bulls sense another leg to the trend

Previous story:
Cable – what is the downside for Sterling?

< Back to menu

Financial Market Forecasting | Bonds Technical Trading Analysis | Commodity Specialist Guide | Daily Indices Guide | Technical Trading Guide UK |
Site Map | SEO Services | We're listed in the UK Business Directory