Stock market whipsaws

Quick recap: last week

A week ago, the Kvarn Pulse newsletter was written in the aftermath of the US midterm elections.

On the Wednesday after election day, the market's immediate reaction to the Democratic victory looked quite positive, with the S&P 500 index having risen more than 1.5 percent. We noted, however, that one-off events often trigger a one-off reaction, and we avoided drawing strong conclusions just yet.

Choppy trading in the equity market

Over the past week, we have seen strong back-and-forth swings in the equity market. Right after the Kvarn Pulse newsletter was published on Thursday 5 November, we saw a sharp one-day drop in which the S&P 500 index fell more than four percent and the Nasdaq 100 index as much as six percent. This decline, however, proved to be just a one-day crash, and this week the S&P 500 index has recovered close to last Wednesday's levels.

In recent days, the Nasdaq 100 index has even outperformed the S&P 500 index and is practically at the same level as last week's Wednesday “election bounce”. It should be noted, however, that the index is still deep below its falling 50-day moving average.

The small-cap Russell 2000 index, by contrast, has already risen marginally above its 50-day moving average.

What should we make of this choppiness?

Right now, we have to remain at least open to the reading that the S&P 500 index is in an emerging downtrend. This reading could, however, be quickly called into question if the S&P 500 index rises above the levels of last Wednesday's “election bounce”, i.e. above 7,690 points.

A more optimistic reading would be that even the sharp sudden drop was not enough to take the S&P 500 index below the lows seen in the summer. In this reading, this drop too would be just noise within a continuing uptrend.

Looking at equity market segments, we can see that investors still appear to favour value stocks over growth stocks. The RPG/RPV ratio, which gives an indication of the relative strength of these segments, has recovered slightly in recent days, but we cannot yet speak of a clear turn in the downtrend.

It should be noted, however, that the weakening of growth stocks over recent months has been exceptionally strong. The fall in the RPG/RPV ratio is already starting to resemble the steepest drops seen in 2021–2022.

A steep fall does not, of course, mean that growth stocks could not weaken further. In our view, however, it is starting to be justified to prepare for the possibility that the immediate downside may now be limited, and we would not be surprised if the market next saw at least a short-term rotation back towards growth stocks.

Market breadth still looks very strong. More than 70 percent of S&P 500 stocks are above their 50-day moving average.

The VIX index, on the other hand, allows for two readings. The absolute level of the VIX has already fallen to around 18. This could suggest that market nervousness has already eased, which would be a promising sign.

On the other hand, if we put the VIX index against the three-month VIX index (VIX/VIX3M), this ratio is still at around 0.95, which can be considered slightly elevated. The ratio is also still above its own 200-day moving average. In this light, we cannot yet say that market nervousness is convincingly over, even though the direction in recent days has been promising.

In addition to the VIX/VIX3M ratio, we highlight the clear strengthening of the dollar in recent days.

The dollar's strength probably reflects primarily the market's increased expectations of future rate hikes by the US Federal Reserve.

A stronger dollar is not unambiguously a significant burden for the equity market, but we cannot see it as a particularly favourable condition either. The clearest effect of a stronger dollar could be expected in the prices of gold and bitcoin, which we turn to next.

Gold back below $4,000

The gold price saw promising upward movement last week, raising hopes of a return to an uptrend. This week, however, that rise appears to have stalled, and the $4,200 level that we identified as an important watershed appears to have remained unbroken.

The gold price has fallen below $4,000, and attention now turns to whether $3,900, seen at the end of October, will act as support again, or whether we will see even lower levels in the gold price.

The slight rise in silver also appears to have stalled, and we have not seen a break above the $55 level.

As an interesting nuance, however, we note that as the dollar prices of both precious metals turned lower, we have not, contrary to our expectations, seen the ratio of silver to gold prices turn down.

We are watching with interest whether this could be the first hint that silver, which has weakened sharply, might be finding at least a relative bottom against gold. If it materialised, this could be a first step towards finding a bottom in dollar terms as well.

It should of course be stressed that this is still early speculation. A rising-rate environment is typically challenging for precious metals, and over the past week we have again seen both gold and silver prices react negatively to growing expectations of rate hikes.

Crypto market falling

Like gold, the price of the largest cryptocurrency, bitcoin, has also been falling over the past week.

For bitcoin, the link to increased expectations of rate hikes is not quite as clear as for precious metals. In any case, over the past week we have seen the bitcoin price fall below $75,000, which appears to be quite an important milestone.

After a break below this level, it is harder to hold on to upward-trending readings, and bitcoin's price action inevitably starts to look like a downtrend. Attention now turns to where the ongoing decline will stop. In August, we saw the bitcoin price move in a one-off jump from around $65,000 to around $75,000, so it will be interesting to see whether the price has to go all the way back to around $65,000 to find its footing.

Within the crypto market, we see altcoins continuing to weaken against bitcoin. This points to caution among crypto investors and is consistent with bitcoin's falling dollar price.

In our equity market section, we noted that growth stocks have weakened so much against value stocks that the immediate downside is starting to look limited. A somewhat similar development can be seen within the crypto market. Since the end of September, the market's centre of gravity has swung strongly towards bitcoin, and we would not be surprised to soon see at least slight “mean reversion” back towards altcoins.

On the other hand, the apparent weakness of the crypto market also raises slight question marks about the equity market. While the Nasdaq 100 index is practically at the same level as in Wednesday 4 November's “election bounce”, the bitcoin price has continued clearly lower over the past week.

Is this a weakness confined to the crypto market, or does bitcoin's downward direction signal that the market's risk appetite is not recovering sustainably after all? We are not yet drawing strong conclusions. However, our confidence in the equity market's upward direction would increase significantly if we also saw the bitcoin price start to recover.

The investment markets are currently in an interesting situation. Last week's crash has been almost fully recovered, and the overall picture of the markets is close to turning upward-trending. Fully convincing evidence has not yet been seen, however, which is why the coming week is shaping up to be a very interesting one.

Wherever the market goes, we will keep following the situation and keep you up to date, so stay tuned!