Market Forecast For The Week Of August 23, 2021

FORECAST: The S&P 500 hits 4490 but then corrects fearsomely towards the bottom of last week’s trading range, as global financial markets are living vertiginously atop an ebullient economic rebound and are now entering dangerous macroeconomic and geopolitical territory. The key issue is the race to stem the COVID mutation, and right now markets are betting with healthcare experts that booster shots taken up in September will protect against the mutations, and the skeptics and ideologues become rational and get vaccinated rather than face government & private sector restrictions. But the possibility is growing that governments lose focus as other failed and controversial policies vitiate their credibility, and businesses react to the recent resumption of large public events with diminished conviction in restricting their customers based on proof of vaccination. Any sign that large segments of the population will remain unvaccinated will hurt market sentiment and fuel a correction.

The bottom line is the underlying foundations of the bull market, namely geopolitical & financial stability, and strong profit growth, remain in place but are attenuating. Geopolitical stability is predicated on confidence that COVID is beaten and economies grow, but this is subject to the growing risks described above. The break in the $US above its double top of last week signals that global investors believe growth is at risk due to COVID, which means business profit growth has peaked and could potentially fall steeply should COVID continue mutating. Strong liquidity is guaranteed for the near-term, but now that US inflation has stabilized above 2%, the risk is growing that central banks stand up to equity markets and cut liquidity since their real function is to stem inflation momentum, not fuel bull markets. That means real interest rates have bottomed and in the current unusual context that is a large negative as higher nominal rates reduce already-high equity valuations. Because of high leverage and high interconnectivity among global financial institutions, any pessimism regarding liquidity and profit growth spills over into global markets and sets off a global correction that feeds on itself.

I see the market hitting new highs early this week before correcting down because investors are in positive spirits due to last week’s rise in profit estimates for several large US firms. More that half of the 100 large firms I track have seen estimates rise more than 5% above what analysts expected 3 months ago. Now that earnings season is ending that ebullience will mutate into fear since there is little chance estimates can keep rising while corporate information flows are flat and delta COVID rages.

Interconnectivity among global banks is key because cross-border bank claims are high (the most recent BIS data shows an increase in Q1 2021 of $646 billion, partly due to seasonal factors but still high, although due to comparisons with Q2 2020 it registered as a slight decline of -0.6% year on year), indicating contagion risk is a concern. EM debt repayment remains murky for badly run nations (e.g., Turkey, Argentina) but moderate global growth is buoying export confidence in major EMs. Fortunately $US liquidity is abundant with no major regional shortages, and there has been no major chatter regarding concentration risk or counterparty risk at large financial institutions.

My current market positions are in American Express (AXP), Facebook (FB), Korn-Ferry (KFY), MKS Instruments (MKSI), Starbucks (SBUX), Titan Machinery (TITN), and nearly hedged position that is net long in the SPX (UPRO and SPXU).