Close to the precipice, good and bad news – 07/05/2023 – Marcos de Vasconcellos

“There is nothing more wrong than being sure”, wrote Millôr Fernandes. And the financial market exposes this maxim. Those who are too sure usually break their face and bankroll. That’s why you have to listen to the optimists, the pessimists and the suspicious all the time.

And there has been an increase, in the financial market, in the number of voices betting on a generalized fall in the US market in the coming months. Make no mistake: a slump in the world’s biggest market is a slump here too. The S&P 500, an index with the largest companies on the planet, guides, to a large extent, our now weakened Ibovespa.

What does this drop indicate, according to managers and analysts in Brazil and the United States? The American central bank, the Fed (Federal Reserve), seems closer to starting to cut interest rates.

The most attentive readers will find the sentence above strange. Isn’t the interest rate cut exactly what the market is waiting for to start rising? The logic is “low interest rates => cheap money => companies invest => companies grow => stocks go up”, right?

The logic remains the same, but — there’s always a “but”— the moment of the US interest rate cut historically happens at the edge of the precipice, when the recession opens the door and companies are unable to pay their debts anymore, defaults skyrocket, banks fail… And that is the formula to bring down the Stock Exchange.

Note that there is no correlation between interest rate cuts and the crash. Quite the opposite. The cut is a sign that the rises led to the crash and, therefore, it is time to facilitate access to money again.

Among the first companies to be hit are those that depend on spending that is considered superfluous. “Where, in a recession, will people be willing to pay US$ 10 for a cup of coffee?”, asks PhiCube analyst Bo Williams, pointing to Starbucks shares as good candidates for short selling operations (the so-called short selling, in which you earn with the fall in the price of the papers).

Historically, the bottom of the S&P 500 is reached 7 to 18 months after the Fed starts cutting interest rates, said investment manager Pedro Cerize, in an interview with the Market Makers podcast. After that, the charts usually show prices going uphill.

The market sees a probability of almost 75% that interest rates in the US will be below the current range (from 5% to 5.25% per annum) after the Fed meeting on September 20th.

The probability of a cut announcement at the July 26 meeting is also not low: 34.5%. This is according to data from the CME FedWatch tool, which compares prices of contracts pegged to interest rates traded in the market.

The good news is clear moves are better for making some money in the financial market. A clear drop makes for big profits with short selling trades. There are, by the way, in the American market, ETFs (funds traded on Stock Exchanges) of short selling, that is, you buy shares of bets on the fall.

In the same way, having the certainty that the bottom of the well has been reached finally brings the assurance that favorable winds will begin to blow.

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