Back in June, I had published what I called the Fear graph (bit.ly/3dr9ILM), showing that the movements in the Dow from December 29 last year were very closely (with a correlation of 70%) tracking the Dow from October 2007, which led into the 2008-09 crisis. At the time (June), the Dow was near 20% down, and while it has recovered a bit and is just about 15% lower today, my concern is that it continues to track that tragedy with the same high 70% correlation.
Back then, the market continued to fall for another nine months, losing a further 35% in the process. Is that where we are headed today?
Nobody knows the future, of course, but my sense is that while things will certainly remain difficult, the market trauma won’t be as bad. The primary reason for this belief is that back in 2008, the entire financial system was sick—or, certainly, was potentially sick—and no one was comfortable lending to anyone since nobody knew who was sitting on unexploded mortgage derivatives.
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Today’s crisis is, in a sense, more vanilla—it is just that the Fed has let inflation get out of hand, multiplied, of course, by the Ukraine invasion. Fortunately, the Fed is seized of the problem, and we can be sure that it will keep pushing interest rates higher, which means that markets will stay off balance but should not fall out of bed. It is hard to tell how long this medicine will have to continue—two years, give or take, is a reasonable bet. Until, of course, inflation does start coming down to where real rates turn positive, in which case, markets may stop falling even though interest rates are rising.
On the other hand, since this problem was generated by years of cheap money, it is certain that there will be several surprises on the debt side, although most of them may be limited to the non-financial sectors. And unless there is some major casualty, the economy could keep ticking over, even if at a slower pace. Thus, the decline to come may not be as furious.
Another point to note is what I call the “temper” of the market. Currently, since the decline started, the market has reacted by more than 1% (upwards) on 35 trading days, far higher than the 27 days over the same period in 2008-09. This also suggests that market is, perhaps, less bearish than it was back then. But, as I said earlier, it could be a slow grind down.
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Another important question is how long will the market take to recover (to its 2021 peak)—in 2008-09, it took four full years to return to its previous peak. And while I am pushing the belief (hope?) that things won’t be as bad this time, it is hard to see how the market could recover in anything less than a year or even two. If you have any planned expenditures over the next three years, it’s probably a good time to cash in some equities and put the money into more liquid assets.
A related issue is the dollar and when it will stop strengthening. The DXY climbed briefly above 110 and came back down; the Euro has trickled to even below 0.99 and crept back up. Both the yen and sterling remain wayward at over 20-year lows, but historically these two are always the wildest movers but are always responders rather than drivers of the trend, like the Euro and DXY. Both of these appear to be coming closer to turning points. Of course, if the equity market continues to edge slowly lower, the denouement in these could also take some time.
However, my guess is that we are NOT going to see EUR-USD at 0.95 or DXY at 115. (Of course, now that I have baldly asserted that, look out!)
In the meantime, the rupee, supported as it is by RBI and continuing (and increasing) talk of Indian bonds being included in global bond indices, is quite calm, even disregarding the horrifying news on the trade front. And, after having first broken through 80 in late July (and even hitting a low of 80.10), it seems quite comfortable swanning around between 79 and 80, as if there is no real threat.
But, of course, particularly when there is no perceived threat we need to be even more careful. I note that since early July, the rupee has traced a sharp head-and-shoulder pattern, which, if it were to break (just a little below 80), would call for a sharp drop to around 81.26.
Careful, careful, careful!