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Fed & War - Data Doesn't Favour Bears

Fear amid uncertainty. It's been the common theme in the markets since October 2021. The 4 month long market uncertainty has lead to speculators overly biased on the short side of the market. Despite the magnitude of fear, major indices are down by 10-15% only. Shouldn't the market would have dropped dead already given the high valuation, after all this is the biggest risk according to the bears right?

Markets seldom unwind when majority of the traders are positioned for a market crash. The sentiment data is right in-front of us for those who wish to see it. Checkout out the last post on how the market lingers around historically low sentiment indicators which ultimately led to big rallies in the past, contrary to the sentiment of the market participant who were expecting big down sides. To make matters worse, geopolitical uncertainty due to Russia-Ukraine tensions has added to the already poor market sentiment o account of US Fed tightening. But, does historical data favour bearish outlook of speculators? No.

Returns vs 1st Fed Rate Hike
Source: FactSet, BofA US Equity & Quant Strategy

S&P 500 has rallied 8% on average for a 6 month period in the past after the Fed announced the first hike. This data is in stark contrast to bearish expectation. Some would argue that PE Ratio wasn't this high on previous occasions, but during the 1999 hike cycle, PE was 30x, higher than today's 24x of S&P 500 and yet market rallied 6% in 6 months between 1999 and 2000. And this was the time the dot com bubble made it's final melt-up! So there goes the bear's favoured narrative.

Returns vs Geopolitical Events
Returns vs Geopolitical Events

The latest market concern is geopolitical uncertainty and speculators have another reason to expect a bearish outcome. But does historical data give them some hope atleast on this? No, it will disappoint them. Again the median market returns over a 6 month period of all significant geopolitical events have been a 7.7% market rally! Unless you are expecting a world war III, the market recovery was done in 16 days! So the folks expecting big sell-offs, positioning yourself for a fortnight of crash?

The fear among market participants is real. Every now and then some generic charts on market cycles props up on social media trying to nudge market participants to expect a crash quite soon or technical charts forecasting 30% market crashes to occur next week and what not. At best these are subjective speculation, unless it' backed by data. A generic one size fits all chart doesn't work. Objective data isn't in favour of the bears. The trader's positional data that I shared from various sources in the previous article is objective data too, which doesn't favour a bearish outcome, at-least on a 3-6 month basis. Though the premise of a larger bear market could carry weight, getting the time-lines wrong can be disastrous. And most speculators get the timing wrong, hence its better to rely on data than opinion. Data suggests a rally ahead, what comes after should be revisited based on the data at that time.

Black-swans do occur and that's the risk in financial markets, but at-least you know what's the probability to play on it instead.

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