top of page

Markets At A Crossroad

When Summer’s hot and you choose to cool off at home by switching on the TV, you casually shift through the channels. You then hear a person’s words “It was a bloodbath”. It is a business news channel explaining to its viewers how ominous the signs are for the stock market. So you stay on the channel to listen-in. The anchor continues, “Sell in may & go away is a popular phrase, what’s your take on that?” The pundit responds with a grim voice, “Global cues indicate we could fall a lot from this level”. And the rest of the experts nod in agreement.


Later that day, you get too bored and start swiping on twitter. You come across a tweet from a person “Won’t be surprised if markets go back to the March 2020 levels", garnering a few hundred likes and comments that explains how the bulls are in depression. Few of them feebly attempts to counter by saying it's still a bull market and they get trolled off. As you scroll further, it's more of the same, forecast of an imminent crash and why you should sell off your portfolio right away. The blue ticks chip-in too with their fancy charts on economy to ratchet up more fear. You join some twitter spaces and it's a complete echo chamber. If you came out of the spaces and did not login to your trading app straight away to sell off your portfolio, well congrats, you would have made Mark Douglas proud!


That's pretty much the sentiment in the markets. Extreme fear, pessimism and a consensus that the market is poised for an immediate deeper correction. And it's rightly so, backed by genuine concerns based on inflation, bond yields going off the charts, central banks rising rates and promising more hikes in an economy that's staring at a recession. To top it off, the markets have indeed backed off from all time highs since the turn of the year. US markets are down 15-20% and Indian markets are down 12%. Some stocks are down more than 50-60%, the rout behind the index has been quite damaging to a casual investor who caught the market in late 2021. If you had entered the markets about a year back, you would be looking at a flattish return. So yes, the fears carry some weight.


Since you know a bit about reading the technical charts, you try to make sense of the gloomy talk by opening up your charting tool. And you do notice that the markets are at a crossroad. Of course, for the market sentiment to have plummeted so much, there must be telling signs of why the sentiment was as poor as it is. Market sentiment reaches an extreme at inflection points and we are near one.


This time is indeed different because you see the correlation between bonds and equity prices broken, something which hasn't occurred much in the past, except ONCE (Bonus chart at the end of the article!!). Both bond prices and equity prices have taken a beating. The general theme the investors have known so far is that bond prices and equity prices are inversely correlated, or also expressed as bond Yields are directly correlated with equity prices (We would be looking at bond yield charts and not the price charts). So what does that really mean when both bonds and equity get sold off. Conclusion is quite simple, people are going into cash (or other assets such as Gold, Commodities etc). When people move into cash, that's your indicator for extreme pessimism, something that happens near major bear market bottoms. But the indices have hardly corrected 15-20%, a percentage that just about enters the bear market territory and not much deeper. Or is it that, people are preempting a major bear market to occur in the immediate future and hence liquidating their assets? Maybe, but when was the last time the majority were on the right side of the markets? When was the last time consensus worked? Is it the beginning or the end of a bear market?

US 10 Year Yields - Weekly
US 10 Year Yields - Weekly

Consensus aside, bonds have made huge moves this year that has left many stunned. But we are near a crossroad. The US 10 Year Yield is at the top of it's weekly momentum cycle. That's an indication that a reversal is on the cards. On the daily time-frame the yield has a sharp divergence to momentum, wherein yields increased despite a loss in momentum which is a leading indicator for a fall in bond yields. This is particularly important for a reason that I will reserve for the end of the article. And, even the Indian 10 Year Yields show similar momentum cycle completion. The IN10Y is near falling trend line mapped since 2014 and the momentum is at it's bullish extreme.

US 10 Year Yields - Daily
US 10 Year Yields - Daily
India 10 Year Yields - Monthly
India 10 Year Yields - Monthly

Equities have been on the downside and that's a chart you would've seen a zillion times by now, so let me skip that for a moment. DXY, the dollar index that measures the strength of the dollar against a basket of other currencies has also been outperforming all other currencies. This is partially due to the risk off sentiment of market participants and due to the yields, Fed policy etc. It's likely that the money being taken out of equity and bonds are hedged by parking them in the dollar. So it's logical to say DXY will play a major role in the equity market's fortunes. And we see DXY also at a crossroad.

DXY Dollar Index - Weekly
DXY Dollar Index - Weekly

DXY has reached the top of a multi year rectangular pattern, a critical resistance zone. If DXY were to slip above this resistance, equity markets are indeed in deep trouble. Luckily though, on the daily time-frame, we again see a price to momentum divergence and the reasoning for a reversal goes similar to the bond yields. Such a reversal would give a much needed breathing space to the equity markets. Coupled with the bonds doing a reversal, it can act as a wind in the back for equities. But all this provided, both DXY and yields dont structurally break out of this crossroad, which if it happens can be quite damaging to stocks. That's the risk being highlighted by the consensus.

DXY Dollar Index - Daily
DXY Dollar Index - Daily

That said, coming to Indian markets, Nifty's chart is particularly set up at an inflection point, a make or break area. Following last week's sell off after RBI raised the interest rates, Nifty is indeed precariously positioned. No wonder there is so much pessimism and gloomy talks on twitter & business channels. Nifty is fast approaching last month's low of 15670. A weekly close below this level structurally threatens the bull market which has thus far seen only a 12% downside. At the same time, Nifty is also set up to give a bounce (could be a bear market rally too) that would open up a possibility of an inverse head & shoulders pattern (a bullish pattern). Visually, if the market bounces off from anywhere between current price of 16411 till 16000, the pattern develops such that it classifies as an inverse H&S.

Nifty Price Structure - Daily
Nifty Price Structure - Daily

The reason for the 2 price levels is 16400 was the low of the left shoulder, while 16000 and thereabouts being the extension of the parallel channel which Nifty has been zig-zagging since October 2021. As the Indian markets react to global volatility, it is bound to get sold off into this right shoulder range for a pullback. If that indeed materialises with the help of DXY and Yields reversing and the extreme bearish sentiments, what you want to look out for is for the index to break out of the channel at least on its fourth attempt. Such a breakout would put the bear market threat at bay as the larger structure would seem to have been resolved as a massive Flag pattern with markets consolidating for over 8 months. Of Course all this assuming a bounce here carries weight and it isn't simply a bear market rally that again sells off before breaking out of the channel. The possibility of further sell off is equally high though. Hence the crossroad.


Apart from the chart which can actually turn either way, market sentiment is a major part of my analysis. When the majority takes a trade, it acts as an inherent shield to itself, because people are already positioned heavily on the same side of the trade. When trades pile up on the same side, the risk reward diminishes. Shorting is the easiest trade out there today with an echo chamber ringing the same views among traders. That is evident from the heavily skewed AAII Bull-Bear spread, PCR data, VIX, Put Option premiums, Sentiment data such as CNN's Fear & Greed index etc. All these indicate consensus on the bearish side. But, Consensus never works.

AAII Investor Sentiment Survey
AAII Investor Sentiment Survey | Source @macrocharts

Now, finally to a chart that I promised . It's interesting because it gives a perspective into a phenomenon that's extremely rare, the bond yields-equity mis-correlation. Whenever bond yields raise (bond prices fall), equity has rallied, when checking for a decently long duration. Differences will be there on a much shorter duration, but for a lengthier period this correlation sticks. But this correlation is completely broken today as both bonds and equity are being sold off. This has never happened in recent times, except ONCE before. And I had to go way back in time to find a similar occurrence, to 1984. 38 years back. Though the situation in 1984 is completely different from now, the trajectory and similarity to today's charts are intriguing despite it being the only notable occurrence.

S&P 500 - US10Y Yields Correlation - 1984
S&P 500 - US10Y Yields Correlation - 1984

Like 2020-2021, where equity markets rallied along with a steady but not alarming increase in bond yields, the run-up to 1984 too had similar moves in equity and bond yields. The difference though is that the magnitude of current time's moves are much sharper than 1984. In both cases, bond yields started increasing rapidly since October of the previous year (October 1983 vs October 2021) while equity went through a correction. Eerily, the months and the duration of the sell correction match too! As yields started topping out in May 1984, the S&P 500 bottomed out a few weeks later. That saw a reversal for the next few months. Bond yields started going down while S&P 500 made new highs.

S&P 500 - US10Y Yields Correlation - 2022
S&P 500 - US10Y Yields Correlation - 2022

With this in mind and recalling how DXY, Bond Yields, Market Sentiment and Equity markets at an inflection point and on a prospective reversal in momentum just about the same time as it happened in 1984, the correlation that happened only once over 40 years on a notable scale…


Can history repeat itself?


PS: As a follow-on read to add more context, you can read my earlier article on how markets have reacted to War & Fed Rate Hikes in the past. These articles help you factor-in alternatives to the consensus opinion in the markets for you to get the full range of market perspectives instead of going down an echo chamber.


Recent Posts

See All

2 Comments


I just wanted to say how useful this blog is for me, it really helped me alot. i hope to see more posts from you soon. Escort Service Gold Coast

Like

This was great analysis in the current market conditions. i hope we cross the worst. Also, we do Financial Planning ourselves in australia.

Like
bottom of page