In addition to this obvious bullish price reversal on the weekly chart, here are five other risk reversal factors that you may have missed.
A credit reversal
Not very long ago, the market consensus was a U.S. recession is just around the corner. Historically recessions are equity bull market killers.
One characteristic of a recession is a credit crunch. The Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS) showed some surprising results. Banks tightening credit standards for corporate loans (blue line, inverted scale) reversed a tightening trend and eased. This indicator has been highly correlated with real GDP growth (red line).
Recession, what recession?
A term premium reversal
Also not very long ago, the market was highly concerned about a rising term premium, or the price demanded by investors to hold long-dated bond maturities. Numerous Fed speakers acknowledged that a rising term premium was tightening financial conditions, which lessened the necessity for the Fed to raise rates. The latest Quarterly Refunding Announcement revealed a lower level than expected supply of Treasury bonds and sparked a bond market rally. The term premium fell as a consequence of lower yields.
Does that mean the Fed will have to raise rates to compensate for a falling term premium? Not necessarily. Improvements in productivity gives the Fed more wiggle room as better productivity is conducive to non-inflationary growth.
In fact, BoA pointed out that productivity improvements have enabled real revenue per worker to near all-time highs.
An earnings expectations reversal
From a fundamental perspective, market expectations of an earnings recession and recovery are almost upon us. FactSet reports that consensus EPS estimates for the S&P 500 calls for quarterly EPS to trough in Q4 and recover starting in Q1. As markets are forward-looking and usually look ahead 6–12 months, any weakness has already been discounted.
Indeed, the Q3 GDP growth came in at a sizzling 4.9%, the Atlanta Fed’s Q4 GDPNow has slowed to 2.1%.
Nevertheless, S&P 500 consensus forward 12-month EPS are continuing to rise, indicating bullish fundamental momentum.
An emerging market risk reversal
I have highlighted how the S&P 500 has been inversely correlated to the USD in the past. The USD Index, which is heavily influenced by the weakness in the euro and the Japanese yen for idiosyncratic reasons, is testing a key support level. However, the more sensitive emerging market currencies (bottom panel) have already rallied above a key resistance level, which has bullish implications for risk appetite.
Callum Thomas of Topdown Charts also pointed out that EM breadth is surging, which is an early sign of improving global risk appetite.
A geopolitical risk appetite reversal
Finally, remember the surprise Hamas attack on Israel and the market fears of what may happen when Israel responded? Since then, while Hezbollah and Iran have used tough rhetoric, they pulled back from participating in the war and the risk of conflict enlargement has receded. As a consequence, the geopolitical risk premium has narrowed. Israeli stocks have begun to recover and oil prices have receded.
This is emphatically not a call to buy the Israeli market, only an illustration of how the geopolitical risk premium has narrowed.
In conclusion, we’re old enough to remember how the market was panicked about a U.S. recession and a rising term premium in the Treasury market. Since then, a series of positive technical, macro and fundamental reversals has occurred to alleviate those concerns. These reversals of an extremely bearish psychology are bullish for risk assets.