Market Predictions Become a Tough Game

Investors are abandoning some of the popular trades of this year as a pullback in the high-profile megacaps could lead to a widespread sell-off affecting assets such as cryptocurrency and gold. This has made predicting the market’s next move more challenging.

The 2024 “everything rally,” where stocks, particularly in the tech sector, were rising, along with gains in gold and cryptocurrency, as well as a strong dollar and emerging markets, might be on hold.

Market anxiety is rising due to stretched valuations in Big Tech, U.S.-China trade tensions, and tepid earnings. The weakness in the results of the second quarter of Megagap shares has unnerved investors ahead of upcoming reports. 

 Investors’ positions are considered pre-risk, but market sentiment remains positive despite stretched valuations there is uncertainty surrounding whether the market will continue correcting.

On the upside, markets are valuation-insensitive, and this remains the same on the downside. The volatility compression that occurs on the way up goes in the opposite direction on the way down.

Tech is currently correcting after experiencing the strongest two-month relative outperformance since 2022. The base case is that the longer-term bull market remains intact, but progress is often two steps forward, one step back

Meanwhile, China’s economy is slowing faster than economists and Beijing authorities anticipated, sucking commodities into the down-draught. Europe’s home-grown luxury megacaps, another favored trade, have shed a quarter of a trillion dollars in value since their peak in March.

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The political landscape has been volatile due to the race for the White House, with Democrat President Joe Biden withdrawing his candidacy for Vice President Kamala Harris shortly after an assassination attempt on Donald Trump. The Republican candidate’s anti-China stance and potentially inflationary policies have impacted chipmakers worldwide and affected U.S. 30-year government bonds.

On the other hand, these narratives can be interpreted to create an excuse for what was probably just some sort of summer profit taking

Despite this, some major investors believe that the current market dip is unwarranted and is being falsely attributed to geopolitical risks.

Recent market fluctuations have seen stocks and other assets like gold, which have increased by 14% this year, being negatively impacted. In contrast, small-cap shares and traditional safe-haven currencies such as the Swiss franc and the Japanese yen have experienced growth.

 This goes beyond just playing it safe.

As the Federal Reserve gets ready to reduce interest rates and doubts arise about the strength of the stock market rally, those carry trades are unraveling.

The latest news puts even more pressure on the dollar. However, yields on shorter-dated Treasuries have gone up this week, bringing them down to nearly six-month lows.

Many investors had been selling the yen to invest in tech. But, with the recent increase in the value of the yen and the reversal of those investment strategies, there’s been some mandatory selling in the big-cap tech sector as well.

Summer trading tends to be light and there is typically a spike in volatility in early autumn. This is a time when investors take profits, which could create a buying opportunity. Many investors, who are used to seeing pullbacks as temporary dips in a bull market and tend to focus on asset prices rather than overvaluations, may agree. 

Further gains will depend on strong second-quarter results and positive guidance for the current quarter. If that’s not forthcoming, expect more profit-taking.

By Farzad Vajihi – Analyst of stock market and cryptocurrency, Ph.D. in economics