THE S&P 500 Index (SPX), which is a broader indicator of the US stock market performance, recently experienced another historical move that added to the list of records that it holds.

       As of the end of last week, the SPX, although briefly traded below the 20% mark from the high of the year and into the bear market territory, bounced back to close just above the crucial 3,837.25 points mark and avoided the official bear market territory – for now.

       Other than bouncing off the lows, the SPX, which fell by 3% the week before, equalled another dubious record – this was only the fourth time that the SPX posted a losing streak of seven weeks or more.

       The three previous occasions were in 1970, 1980 and 2001 based on passed data.

       Interestingly, according to one research report, the index was negative over the next 12 months each time this occurred. The benchmark US index, the Dow Jones Industrial Average, achieved the unthinkable too as last week’s 2.9% drop was its eighth weekly losing streak – matching records that date back to 1923.

       Before last week’s Thursday’s drop on the SPX, there were just three previous occasions when the SPX fell by more than 4% and then dropped again the next day.

       The three previous occasions were during the Global Financial Crisis of 2008, the downgrade of US credit rating in 2011, and the March 2020 post-Covid-19 market crash.

       Interestingly on each of the previous three occasions, the Federal Reserve (Fed) stepped in to provide market support either via a massive rate cut or quantitative easing.

       This time is different

       Haven’t we heard that before? In fact, every market sell-off is led by the belief that “this time is different”. Well, guess what? This time it is different. Why so?

       Firstly, in previous market sell-offs, the markets were not grappling with inflationary threats or geopolitical tensions like the current Russian-Ukraine war.

       The Fed stepped in to provide market support that allowed the market to bounce back from the loss of confidence and a “Fed Put” helped to calm sentiment.

       But due to Fed’s “Johnny come late” move in raising rates and falling behind the curve, the Fed cannot afford to pull the brakes on its lift-off policy as the message it has delivered to the market is not only aggressive but one that will even remove the liquidity in the market with effect from June 1, via the Fed’s quantitative tightening measures, starting with US$95bil (RM416bil) next month and as much as US$1 trillion (RM4.38 trillion) over the next 12 months.

       Second, although the market has bounced off this week, up 4% on SPX and the 4.4% on the Dow up to Thursday’s close, the market remains under pressure with further selling on the horizon.

       History had shown, that it was not just the massive liquidity that was created after the pandemic that enabled markets to gain footing and rebound from a major sell-off, bear markets only end after the Fed floods the market with liquidity and that is indeed not forthcoming this time around.

       VIX failed

       The third is the market’s measure of greed and fear via the VIX. Most investors are familiar with the VIX – the short form of the Chicago Board Options Exchange’s CBOE Volatility Index, a popular measure of the stock market’s expectation of implied volatility based on a basket of 30-day options on the SPX.

       VIX is a measure of demand for options – puts versus calls – on the SPX. When demand is strong for puts then volatility is rising, and options are becoming more expensive as players seek protection from a potential market drop.

       The VIX is also seen as a measure of fear and greed.

       When readings are low, the market sees calmness and investors’ greed takes precedent and the market tends to be on an upward trajectory with bullish momentum.

       However, when the market is at a point of uncertainty and volatility increases, so does the reading on VIX.

       The VIX was last seen at just 27.5, less than double the 52-week low of 14.1 but well below its 52-week high of 38.94.

       Even the great sell-off on Wednesday, May 18, did not see the VIX indicator spiking up fiercely as it only rose to just below 31. Investors could recall during the market turmoil just at the beginning of the pandemic, the VIX surged to as high as 65.54 in late March 2020 and as high as 79.13 just post-Lehman Brothers in October 2008.

       Market fear at that time was unprecedented but not so this time around. Why is this so?

       According to Goldman Sachs, over the past 15 years, there have been 36 daily selloffs of 4% or more, and the VIX was never as low as it was on May 18.

       As VIX is a risk management tool deployed by hedge funds, the actual VIX level is no longer a measure of greed or fear as it used to be but more of traders’ bet on the market’s volatility which no longer adequately measures the greed or fear factors.

       Recession looming

       Fourth, the United States economy may be headed towards recession.

       While the 10-year and two-year US Treasuries had a brief inversion recently, the rising inflation prints over the past few months saw even the 10-year rate rising to the 3.20% mark and thus negating the inversion and any talk of recession.

       The 10-year US Treasuries has since rallied and was last spotted at 2.75% as investors are also rushing toward US treasuries due to the strength of the dollar while long term inflation expectations as measured by the 10-year breakeven inflation rate has dropped by 40 basis points to 2.62% from the peak of 3.02% a month ago.

       In any case, the US treasuries is not the only gauge of recession as even the stock market moves can be analysed in detail to predict what is the market pricing at the current level.

       According to one economist, David Rosenberg, in a tweet message on May 20, “in the past 50 years, every 18% slump in the stock market over a four-month-or-longer period foreshadowed a recession.

       And recessions, on average, see the market slide 30%. So, no – we’re not “there” yet”.

       Several other well-known economists too are painting a recession scenario, perhaps not in 2022 but into 2023, especially on the back of rising Fed Fund Rate to as high as between 2.5% to 3% and the Fed’s move to shrink its balance sheet starting in June, which will take away market liquidity.

       The stock market is always ahead of the real economy and with the market flashing all sorts of signals.

       Economic data-wise, it is not looking good either. Inflation and slower global economic growth are raising bets of stagflation while recession looms perhaps within the next 12-18 months.

       Recent indicators from new export orders in the manufacturing Purchasing Managers’ Index of the US, China, Germany, and Japan have fallen below 50 which suggests that global economic momentum is slowing down with weaker export orders.

       Time to play it safe

       With rising interest rates, slowing global growth, and persistent inflationary pressures, the next economic downcycle has already begun, and that is what major global equity indices are pricing now.

       With both the equity and bond markets taking a hit since the start of the year, it is not too late for investors to raise their cash levels and reduce market exposure given the uncertain economic outlook ahead.

       For those still in the equity market, switching to a defensive-oriented portfolio would likely shield investors from market gyration as growth stocks take a back seat.

       Pankaj C Kumar is a long-time investment analyst. The views expressed here are the writer’s own.