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Overstretched?

 In Newsletter, Newsletter Pro

Issue 143

Assets Covered: ICE USD Index Futures (DX1), EUR/USD Rate, Russel 2000 Index (RTY), United States Dow Jones Stock Market Index (INDU)

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Markets have been a bit tentative in October. After a 6% decline in September, the S&P 500 is up around 1.5% through mid-October. Markets are steady, but not strong in either direction. That’s troubling.

 

Just last week, Goldman Sachs’s legendary analyst Abby Joseph Cohen stated that the stock market could face the possibility of significant declines ahead of the US election. Whether it’s before or after the election, we are concerned here.

 

Our first stop is always the US Dollar. After seeing significant decline in the US Dollar index (ICE DX1) through August, the Dollar index has settled just above 93. Last time we saw the Dollar at this level, weakness remained for a year (July 2017-Jun 2018). We had originally expected the Dollar to perk up in Q1 2021, but we no longer expect that. Price action, demand slowdown and other factors have changed the rate of recovery for the Dollar.

 

CHRIS/ICE USD Index Futures (DX1)
CI Futures generated this chart. Book a demo to see it live in action.

 

With a weaker Dollar, we expect the Euro remain strong well into 2021. Brexit and the Covid second wave are certainly concerns for the Eurozone, but Europe’s status quo is expected to remain intact.

 

EUR/USD Rate
CI Futures generated this chart. Book a demo to see it live in action.

 

While the S&P 500 has seen a lacklustre month, the Russell 2000 small cap index has seen a healthy 5 percent rally. Small caps have made a steady climb back from the Q2 lows. Despite the near-term gain in small caps, we expect a change of direction in December with a slight decline going into year-end.

 

Russel 2000 Index (RTY)
CI Futures generated this chart. Book a demo to see it live in action.

 

Large caps are a different story. We’ve seen a similar, steady rise in large caps post the Covid lows. Valuations have risen, while earnings have fallen year on year. FactSet has expected Q3 large cap earnings to contract -20.5% year on year. That’s bad, especially with the expectations-based valuation expansion we’ve seen in Q3 and the hope of further stimulus from the US government fading.

 

United States Dow Jones Stock Market Index (INDU)
CI Futures generated this chart. Book a demo to see it live in action.

 

 

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