AvaTrade News: The Best Trades for Bearish US Equities

When it comes to these top trade installments, I usually take a methodical approach. With a major emphasis on FX, I've developed a method that works for me. See, when I deal with FX, I usually stick to large pairings like EUR/USD or AUD/USD. In many situations, I'm attempting to hedge some aspect of risk while concentrating my exposure in a planned way. I often look at cross pairings for top trades since the themes I've been working within majors may sometimes filter out into longer-term opportunities in a cross. As an example, consider the GBP/JPY rate from the fourth quarter of last year.

I was simply hoping to play the GBP strength trend against the projected JPY weakness and, rather than setting up GBP/USD and USD/JPY separately, just cut out the middle guy and go straight for GBP/JPY. My top trade from the first quarter of this year was significantly simpler: I was optimistic about the USD as I saw a rising convergence of fundamentals and techniques that was tough to ignore.

However, for this quarter, there is just one place that I want to look at for a top trade, and that is stock weakness, notably in the Nasdaq 100 and the S&P 500

I understand that the worry of rate rises looks to be exaggerated. After all, the Fed has the authority to decide how swiftly to raise interest rates. And in the past, when this has been a problem, they have erred on the side of prudence and equity strength. Even today, equities have continued to trade well despite several troubling signs that market participants seem to be dismissing. And, in truth, this isn't that unlike the previous 13 years, is it？ It's seemed like one disaster after another since the Global Financial Collapse. There seem to be a million reasons for stocks to fall, but bears have been met with a steady stream of disappointment as equities have put in a spectacular run over the last decade-plus.

But I'm going to use one of the most hazardous expressions in financial markets, one that I seldom, if ever, use: I believe this time is different.

The Fed is different this time. We haven't had to worry about inflation since the 1970s, which is before my time. And, although the Fed was cautious with QE after the banking sector imploded as a result of the housing bubble in 2008, a lack of inflation enabled them to be more proactive with policy. So much so that markets struggled to function without it, even during periods of good economic pressures, such as 2018.

But, after Covid, and armed with the absence of fear that came with deploying QE for a decade with no direct negative consequence, the Fed went crazy and didn't even begin to rein it in until it was much too late. Inflation has risen, catching the Fed by surprise despite its constant assertion that inflation was temporary throughout last year. They now have to play catch-up.

Just as the Fed has begun to raise interest rates in an attempt to halt 40-year high inflation rates, there is another huge concern on the horizon, which presents even greater inflation potential from the surge in raw materials caused by Russia's invasion of Ukraine. The global economy has grown too reliant on free trade and the unfettered movement of business. That no longer exists, and add to that a little antagonism, which may cause even more issues, such as Russia barring ships bringing wheat, causing an even worse supply bottleneck. From an economic standpoint, it seems that we are already in a Cold War 2.0, and the dismantling of trade relations is unlikely to help either side. This may result in an even more pronounced inflationary tendency.

And all of this adds up to one thing: the Fed put seems to be dead, or at least it appears to be dead until the S&P 500 loses a thousand handles. And, technically, this would be the first time it has occurred in such a way since the global financial meltdown. There have even been statements from Fed members about orchestrating a “soft landing,” which sounds like they want stock prices to fall from their present levels.

To summarize, inflation is out of control, and we are on the approach of, or possibly already in the middle of, an economic war with another nuclear power on whom the rest of the world relies for commerce. This might lead to global food scarcity, putting even greater strain on the world's most vulnerable countries and people. This may lead to further conflicts, such as the Arab Spring, which started in 2010. And the Fed, which has been quite helpful through a lot of economic calamities over the last 13 years, no longer has the power to support markets in the manner that everyone has been used to. They'll have to trek, which will just add to the burden.

This suggests that the US dollar is strengthening while equities markets are weakening. USD strength was my top trade for Q1 2022, and although I believe the short equity thesis has longer legs, it also has a more difficult background, therefore I'm going with short stocks for my Q2 2022 Top Trade.

The S&P 500

The S&P 500 has already retraced up to 23.6 percent of the previous trend. The index could conceivably retrace 38.2 percent of the same large gain while still having some longer-term positive characteristics. This sector is projected to reach about 3800, at which time the loss from the January high would reach the 20% bear market territory level. This seems to be a potential support level for S&P 500 pullback themes.

WEEKLY PRICE CHART FOR THE S&P 500

The NASDAQ 100 index

The Nasdaq 100 has already made a brief foray into “bear market territory.” In Q1, the index traded below the -20 percent loss threshold for a brief period, compared to the S&P 500's maximum drop of -14.69 percent.

If the rates theme drives a deeper correction, I believe the Nasdaq has more negative potential than the S&P 500, and I believe we might see a larger sell-off here.

The 50 percent level of the epidemic move is about 11,700, representing a 30 percent drop from the all-time high hit in January. There's also a broader zone of interest that's a little deeper, ranging from roughly 10,501 to 10,750. This would be a 35% drop from the November high, and if we're in a true correction theme, that doesn't seem like a completely unreasonable support target, though something like that may take some time to build, so it might not show up until the second half of this year in a larger overall market correction.

WEEKLY PRICE CHART FOR THE NASDAQ 100