FX.co ★ Stock market to come under bearish pressure soon?

Hi dear colleagues!

A series of events this week could become market movers for the US stocks that could reverse trading sentiment. I mean corporate earnings reports of top US companies, the Fed's policy meeting, and the IMF outlook for the global economy. Let's figure out these factors in my article and try to reckon prospects of the US equity market. January is about to finish soon.

On Tuesday, the International Monetary Fund released an upgraded outlook for the global economy by 0.3% which is expected to grow by 5.5% this year. Such a revision became possible amid the mass vaccination in many countries worldwide as well as amid extra stimulus measures in the US and Japan. Nevertheless, short-term prospects remain gloomy. Among developed global economies, the eurozone is likely to be the hardest hit by the pandemic with the worst prospects for a recovery. Breaking down the eurozone countries, France' national output is expected to contract to -9%, Italy's GDP is expected to slump to -9.1%, and Spain's GDP is expected to shrink -11%. Germany's economy could drop to -5.5%. All in all, the total GDP of the euro block is projected as low as -7.2%. These are forecasts for Q1 2021. On the other hand, the eurozone's economy could revive in 2021 with its GDP at 4.2%. The UK GDP is expected to tumble to -10% in Q1 with the projected 4.1% growth for the whole 2021.

China seems to outpace other advanced economies. Its economy could have expanded by 2.3% in 2020. China's GDP is projected to climb another 8% this year. Russia's economy could have contracted by 3.6% in 2020 and is likely to grow by 3% in 2021. India's national output is expected to fall to -8% last year with the possibility of an 11% growth in 2021. Japan could have tumbled by 5.1% in 2020 and is expected to rise by 3.1% next year. The US economy is projected to decrease by 3.4% last year. The top global economy could rebound by 5.1% in 2021.

The worst crisis since Great depression crippled the whole global economy. Experts foresee a fragile economic recovery this year. In means that in 2021 incomes of the population in 150 countries worldwide will be lower than in 2019. The US Federal Reserve unveiled its policy statement on Wednesday, January 27. The decisions confirmed the regulator's intention to pursue dovish monetary policy until unemployment in the US declines to the levels intended by the FOMC. Interestingly, this is a prior goal despite the probability of higher inflation. The thing is that the Fed's target inflation level is firmly around 2% in the medium term which means 2 years. At the same time, the Fed has not set the target unemployment rate. In essence, ultra-soft monetary policy could last indefinitely. According to the policy statement by the Federal Open Market Committee, the central bank is due to inject the total $120 billion per month into the economy. $80 billion of it will be provided in exchange to US Treasuries and $40 billion – in exchange to mortgage securities. In other words, the US regulator is set to emit $1.44 trillion in the national economy in 2021. This is certainly a bullish sign for stock markets.

The problem is that a stimulus plan proposed by new President Joe Biden worth $1.9 trillion has not passed yet. The bill could face obstacles in Congress where Democrats has minor majority. Corporate reports which are due next week are likely to reveal tepid revenues in Q4 2020 that evidently dents investors' optimism. On Wednesday 27, the US stock indices logged the sharpest fall since October 2020. The reasons are obvious: tepid financial records, delays in the vaccination campaign, and soaring coronavirus rates. Interestingly, the VIX volatility index surged to 37 whereas the normal level is slightly above 20.

Picture 1. Technical picture of SP500, daily chart

The technical picture for the SP500 suggests preconditions for the bearish reversal. Let's consider it in detail. To begin with, a daily chart reveals prospects of the index for a term of 3-6 months. As we see, the index and the whole US stock market is in the bull market. Nevertheless, crucial changes occurred in the market on Wednesday that deserves special consideration.

According to the chart, the index has been creating a reversal pattern for five days straight. I mean the reversal pattern called Double top which eventually was formed on Wednesday, January 27. The price broke the bottom line and closed at the level below a 20-period MA. This has never been seen since October 2020.

A 20-period MA means an average monthly level. A closure below this level opens the way for the index downwards. Apart from passing the level of the Double top's base line, the price clearly has prospects for a further decline. In the chart of the MACD indicator, we can watch a formation of the downward signal. This suggests a correction of the SP500 to the level of a 120-period MA which reflects average prices in half a year. In this context, the ongoing rally of the SP500 which has been underway on January 28 is just an attempt to revive the trend. Thus, I can reckon a further decline of stock markets for the term of 3 to 6 months. The first target for the SP500 is seen at 3,500 that is 10% lower than the current level.

Importantly, this bearish scenario could be cancelled. Things will clear up on Friday, on January 29, on the final trading day of the month. If the index closes the day above a 20-period MA and above the foundation of the Double top, this will create technical preconditions for a further rally with new historic highs to follow.

On Thursday, January 28, the market got to know a preliminary US GDP for Q4 2020. The US economy tentatively sank 3.5% in the final quarter, thus logging the worst contraction since 1946. In response, the US equity market resumed growth in the hope for new stimulus. Still, I guess this is just a temporary bounce before a further plunge under the bearish scenario. To be honest, I have a gut feeling that the stock markets are on the verge of a decline. Intuition comes from experience. I wish I were wrong. I urge you to be cautious and follow the rules of money management.