Is there an ideal combination to identify market lows? Apparently yes, but with due precautions.
It sounds like a real provocation to be able to identify the market lows, yet there are macroeconomic and technical conditions that make it possible to identify them in an approximate way. How is it possible? We can identify an "ideal" macroeconomic condition” to see a long-term market minimum situation, a sort of condition from which one cannot get any worse unless there is a collapse of the economic system.
This situation will be related to the previous analysis of the correlation between unemployment rate and stock market performance over the last 30 years, where we took the Nasdaq trend in a one-month time frame and the US unemployment rate, also it a time frame one month.
High inflation, rising rates and rising unemployment
The title of the paragraph says it all with respect to the ideal condition to see a minimum market. In essence, a high inflation situation is a situation that central banks don’t want to be in and as we know, it is relatively easier to bring inflation down than to get it up. It seems crazy what has been written, but we are no longer in the 30s or 70s where economic policies and the structure of the money market were very fragmented and each nation had its own economy and central banks thus having a situation of independence on all fronts.
We could hardly see a situation of very high inflation in economies that share a different economic and financial system, see for example Europe with its different component nations, as well as the United States composed precisely of the federal states that also have their own internal rules in terms of economic and fiscal policies. In essence, this financial system is historically designed to avoid hyperinflation dynamics by means of greater control over money by central banks.
In essence, the impact of a central bank rate hikes has a much greater influence than it did in the last century, so it is probably very difficult to see a hyper-inflation situation. In fact, some have spoken of this market phase as the worst since the euro existed in terms of inflation, so much so that there has been talk of a situation of hyper-inflation even if this is not yet present despite being well above the 2% target. In essence, it is much easier to control inflation with rising interest rates, and therefore rising interest rates lead to an almost inevitable fall in inflation.
Attention, the drop in inflation must be accompanied by a situation of economic slowdown which leads to a drop in productivity and a consequent worsening of the labor market with an increase in the unemployment rate. Well, we have come to the point, the unemployment rate which increases as a result of the drop in liquidity due to central bank policies. Let us now analyze this point.
Unemployment rate as an indicator?
The unemployment rate is configured as the last link in the chain, becoming a real sentiment indicator for central banks and beyond. As it happens in mathematics, let’s assume by contradiction that the unemployment rate rises to historical levels never seen before, how will a central bank move in this situation?
First of all, it is assumed that a very high unemployment rate is followed by sharply declining inflation, therefore an ideal condition for central banks to lower interest rates, reintroduce liquidity into the economic-financial system and then restart all the economy. We also recall that central bank policies are drivers for investment decisions as the amount of liquidity present in the system will have to be allocated to the financial markets. In essence, a hypothetical all-time high in the unemployment rate would coincide with a restart of the economy, a sort of minimum indicator of the economy.
In practice, when we see the unemployment rate at its maximum, in correspondence with falling inflation and substantially unchanged rates, then we could speak of a market minimum. This condition is currently still a long way off, which is, we have high inflation, central banks that are still raising interest rates, and an all-time low unemployment rate. In practice, we find ourselves in the situation where we are at market highs, ready for a rise in the unemployment rate which, as we saw in the article on the correlation between unemployment and markets, coincides with the beginning of a market bearish phase.
Furthermore, this condition also explains this bullish phase which we have been witnessing for a few weeks now, a situation that many operators are unable to explain except with a decrease in the unemployment rate which, coincidentally, coincides precisely with further bullish accelerations of the markets. We also have the central banks who have stated, especially the US Fed, that they will raise rates until we see inflation return within the expected targets.
At the moment therefore we have to wait for the drop in inflation and the repercussions of the increase in rates within the economy to be able to see a recession. Only a recessionary phase leads to an increase in the unemployment rate and in fact the beginning of a real downturn in the markets. We’re basically more than halfway there as still missing the recession and rising unemployment rate, basically still a little bit of time before we see a full-blown market crash.
We can conclude by saying that, not only does an increase in the unemployment rate coincide with a long-term market downturn, but we can also say that a very high level of the unemployment rate coincides with long-term market lows lows that could hold prices up for years to come.
Original article published on Money.it Italy 2023-02-14 08:57:00. Original title: Trading e investimenti, è possibile individuare i minimi di mercato?
