Is A Market Crisis Coming? 3 Important Signs To Watch
Talk of global recession is gaining momentum as we begin 2023. Here are three signs which will indicate that a broad market selloff is imminent.
Before we begin, it is important to note that a broad market selloff occurs when all markets are aligned on a cyclical basis. This means that the general idea behind looking out for indications of a coming selloff rests on understanding where important markets are trading in their own cyclical patterns, as well as how they normally trade just before inflection points.
1. The Dollar Strengthens, Or Remains Strong
As you can see from the chart, the Dollar (DTWEXBGS) was the first market to turn, way back in mid-2021, signaling that USD funding conditions were beginning to tighten across the globe. This is the precursor to all global recessions.
As we begin 2023, the USD has sold off, but remains much stronger globally than it was compared to its weakest levels in 2021. In other words, the Dollar is still signaling that a global economic contraction is on the horizon.
2. Eurodollar Futures Turn Higher
Eurodollar futures are one of the main ways participants in the global financial system hedge against changes in short term US Dollar interest rates.
From the chart below, you can see that they have spent the last few months selling off, as the Fed has been hiking rates. Conversely, should Eurodollar futures prices turn up, it means that the market is beginning to price in lower short term USD interest rates (remember that interest rates run inverse to prices in fixed income instruments).
Put another way, Eurodollar futures getting bid implies that the market is expecting the Fed to start cutting rates.
Lower short term USD interest rates, projected by the Eurodollar market, would bring it into alignment with global Dollar strength. This is due to the fact that lower rates, especially during times of market turmoil and economic crisis, do not actually indicate an abundance of liquidity. On the contrary, low rates in crisis periods indicate hoarding. For more information on this, refer to our articles on the Interest Rate Fallacy.
Bear in mind that the Eurodollar yield curve is currently inverted, just like the yield curve for US Treasuries. Both markets are massive and global, and both are indicating that liquidity conditions around the world are getting very tight.
3. Equities & Commodities Moving Lower
Equities have already turned lower in the current cycle, which is unusual, as they normally are the last, if not one of the last markets to turn, just before the global economy tips over into contraction and possible crisis.
However, should the world economy continue to move towards recession, it is quite likely that equities will rally, possibly quite strongly. This behavior is normal and is simply due to the fact that many equity market folks hold strongly to the paradigm that lower rates are good for stock prices, and higher rates aren’t.
The factors that determine stock prices (and in every other market) are myriad and complex; reductive statements claiming simple causal relationships between one factor and how it affects prices tend to be more folksy than accurate.
Should Eurodollar futures start to move higher (implying lower rates), equities start to rally, and the Dollar strengthens, it would be advisable to not bet too much on a sustained trend higher in stock indices. In fact, should such a scenario materialize, it might be wise to look into ways of getting short equities.
Other markets you can use as indicators of an impending slide towards a broad market selloff include the price of oil and copper. Both are sensitive to global growth conditions, although micro factors are important to consider in commodities markets.
Oil for example, is currently affected by Russia’s war in Ukraine, which naturally acts to keep its price elevated. With this in mind, should oil begin to trend firmly lower, it would indicate that global economic conditions are rapidly deteriorating, to the extent that even war-related supply disruptions cannot keep prices high.
If you would like to know how to prepare and profit from trading a crisis, you can learn to do so in our course on How To Make Money Trading A Crisis. The course will teach you about the market cycles mentioned above, how this relates to financial markets, and most importantly, which markets to trade and why.
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