2023 could well be a lot better than anyone thought a few months ago – but how will the market trade?

A US recession is coming and many remain underweight equities waiting for it. But what if this time is different...

We all know the stats – every broker and fund manager knows them – if and when the US goes into a recession (as expected later in the year) then we all know that the market does not recover until after it has collapsed by 30%.

So those overweight cash, short equites or short all continue to wait for that to unfold – but so far the market is not behaving “as it should”. 

In this wire, I run through the main factors, as I see it, that explain the market's performance over the year to date, and what investors should be watching out for in the months to come. 

As you'll read, the interplay between China's re-opening and the resources sector could be the best bellwether we have for markets at the moment.

Please note this is an excerpt from The Coppo Report.

Enemy #1

The US recession is expected to hit the brakes as a result of the US Fed's most aggressive tightening seen in almost 30 years and all the other tightening have led to a recession – so this will as well.

But why is the Fed tightening? To kill inflation - that’s their number one job.

The only thing is that inflation, this time, came from the COVID response with stimulus payments and lockdowns seeing cash balances soar and then with the supply chain disruptions we saw too much money (demand), chasing too few goods. So the result was inflation.

Now since then we have seen cash balances dwindle (but still plenty seem to have cash), but more importantly supply chains are reopening (and the biggest one of them all China – after 3 years of being out of action – is about to come back on stream and that will alleviate a lot of the supply issue.

We have already been seeing many of the inflationary prime suspects now in retreat– oil, natural gas (from US$10 last year to now US$2.50), coal price, food, used cars prices, shipping rates (rent is the big one that we need to stop rising - and it looks that that is finally happening).

So we know this has been occurring, thus we know inflation will coming down – ok will it be soon or later– who cares - you know it’s going to be down later this year or early in 2024.

We are all now waiting for the big January – whoops – now February selloff

Back in August last year I was of the view that we’d see the US selloff in September/October and the market would re-test its June lows in October and that would be a major low in the market (more bear markets have finished in October than any other month!!) and then we’d see a huge (yes I did say many times a ‘Bear Market’) rally into early January 2023.

Then from there we’d see a selloff of maybe -10% over January/February and March and then see the final Bear Market low in mid-March 2023.

Now the first part was ok, but the selloff I was expecting (in January) has not occurred.
One thing that has worried me was that in late December many US strategists came out and called for a big selloff in early Jan– with a bottom in the 1st/2nd quarter and then a V-shaped recovery.

So now my view was the same as many others and one thing I know is that when YOU “are consensus”, then the chances of being on the right side of that call are greatly diminished !!

So now many institutions and brokers all agree that an early year selloff was coming and then a V recovery – so if everyone was now expecting that.

Is the Iron Ore/resource story telling us something about why markets are surging when they “should have been” collapsing? 

So maybe “the market” is taking the view that we know the US market is going have a massive 2nd half rally – so why not “just look through the valley the other side and get set now?

This view is a huge concern to the Bears – they need a selloff to get set – before that happens. 

Maybe the Iron ore moves last year – that were supposed to also be down – are a signal of how markets may move in 2023? The Australian market continues to outperform the US as the China re-opening story is seen as a huge win for the Australian economy.

Anyone who owns or is overweight resources (that are in a bull market, I might add) knows what I mean as the China reopening story has seen commodities rebounding.

Late last year I remember a number of brokers were downgrading their iron ore forecasts from US$90 to US$75 due to the China COVID zero policy and other analysis that showed the demand was very weak vs supply.

A few brokers had target price for Fortescue {22.52 0.04 0.18%} of $14 - it did drop from $18 to $16 after the big brokers did these downgrades and some institutions faithfully followed those calls ) – also they had the low Fortescue (ASX: FMGcall because their “macro” analysis was that if their Iron Ore price target been correct (US$70) the TP would been right as well, but the Iron Ore price rallied – instead of dropping further. That was not meant to happen – China was in a “lockdown” and COVID Zero was going to last for a long time!! But the market does not follow the experts – it does its own thing and looks way beyond the horizon.

China has only just started re-opoening

Now since then, the Iron ore price now been surging for 4 months! Yet China’s reopening is only happening right now.

That chart above is not what anyone was predicting... China was closed and not reopening for a long time!

Now I clearly remember the resource/iron ore bears (a number of the big brokers were hotly on this trade) made a very clear argument and logically it was 100% fool proof.

We were in October and the world looked bad (US/European recessions coming Inflation surging/a freezing winter was going to hit in December cause energy prices to soar further) but China was looking really really bad - Xi Jinping had his ZERO COVID policy in place and was (at that time) 100% determined that they would lockdown as long as they needed to ‘eliminate COVID’ from China.

We all knew that this policy would be in until at least February / March 2023 (but some thought it could be much longer) – so anyone investing in any stock that was “China related” was an idiot and a fool who was “not looking at all the bad news right in front of their face"
could they not see that China was “shutting down” its economy for the next four to five months (or more – no one knew).

So we were basically going to see China go from boom to bust and then one day hopefully back to boom but the boom would not be until well after they had “re-opened” and got their economy back to full capacity and that would not be until maybe the 2nd quarter 2023. 

But then something happened – the “market” in iron ore and resources went off-piste – they didn’t fall, but rallied.

This made “no sense” COVID zero was a disaster for China (and the world) and we saw the “evidence” when they released GDP for the fourth quarter that collapsed one full percent point from 3.9% to just 2.9% (chart below). The Bears knew this Iron Ore rally had to come to an end soon.

The Iron Ore price did not “collapse” as many were expecting...

But the bust that so many were waiting for never came (well it did but is was sharp and short and was only down for a very very short time – that was the final selloff from US$100 in Sept to US$75 in October).

Now – this is where the “market” can confuse us - the recovery in Iron Ore - that many (most) were all expecting to happen 6 months later in the first or second quarter of 2023 – was already occurring in late 2022 from November – right in the midst of a complete China lockdown.

It is just another example of how the market ignores the bad news around it and looks “forward”. 

This was – as we see so often – the market looking way ahead of what of happening around them at the time. The market saw the end of China Zero one day in the future and was already “looking 6 months ahead”– at the exact same time that the most senior strategists were urging caution on resources as there was still “too much uncertainty and bad news” in China.

Ok, that’s how markets work and I’m sure many will now see what an easy trade it was – but back in November 2022 – most were not calling for the rally we have seen (and as a FMG/MIN shareholder was feeling the pain with Mineral Resources (ASX: MIN) {90.96 -0.23 -0.25%} hitting a low of $43 and Fortescue {22.52 0.04 0.18%} low of $14.50). 

Now China has got rid of its ZERO COVID policy and is reopening

Given the rest of the world has already done this a year ago – we now know exactly what will happen in China in 2023 and their economic recovery will be robust.

They have been out of action for the last 3 years and will be coming back on in a big way through 2023 and we have all seen a sneak preview of what happens after seeing the other reopening across the globe – which is why I remain super bullish on resources in 2023 and 2024.

That’s good as we know the rest of the world is about to “slow down” and so China will be able to carry a heavy load in 2023 and “cushion” (especially for Australia) the burden of slower world economic growth.

So I remain a bullish on resources in 2023 – but there are many who have “missed the boat”, and will be buying into this new (and unforeseen by countless) China re-opening story.

However that just means we’ll see some really big price surges in the next few months in the resource stocks that could become (for traders) short-term selling opportunities as retail and others come back into the market. 

But as I alluded to – this resource rally could be telling us a lot about how equities will trade in 2023.

Now we have seen how the resource stocks moved in late 2022 when – despite so much bad news they “looked through the valley of death” to the recovery (on the other side) that was coming later on.

So I find this market now so fascinating (as everyone else I speak to does as well) = the experts all agree that the US recession is a near 100% certainty – there is just too much evidence that it’s coming –

So much bad economic data just keeps coming. But the markets keep ignoring it and Goldman Sachs have lowered their odds of it happening to 25%.  So GS are saying there is a 75% chance of NO US recession- if the market takes that view then the bears will be buyers on any dip that comes rather than waiting too long.

For how much longer can markets ignore the bad economic data?

I suppose there is one key element that is still missing and its a really big one – a “surge in US unemployment” – that could be the key or the catalyst or the trigger the next selloff – when it eventually comes.

But for now – alluding to what we have seen in the resources markets for the last 6 months –the bust cycle was too short – it was expected to last 6 months but was over very quickly (with markets bouncing despite all the gloom and doom about China still raging around them).

Most strategists (and hedge funds, institutions, quant funds, momentum funds, experts, traders and of course the media) all know a US recession is coming and the strategy is very, very clear – do not BUY now before Armageddon comes later in 2023.

As has been stated “the US market has never bottomed” before a US recession.

Goldman Sachs and Morgan Stanley – had for the last few months been calling for the S&P to trade down to 3000 before this cycle is over...and that would represent a -28% decrease from current levels (it was only about -15% from when they first started calling this dire prediction). GS may have changed that view given their new US recession call.

Everyone is looking for the “same thing” – so will everyone get it right!

They have the same playbook –we go from boom to gloom when US recession hits and US economy slows, but then in 2024 - a massive boom. As I have said many times – having gone through the 1987 Crash, the 2000 Tech wreck, the 2011 European debt crisis, the Global Financial Crisis (GFC) and more recently COVID in 2022– they were all scary and unpredictable with the damage they wreaked on world economies and stock markets.

Everyone has seen this and thus they know the US recession is coming.

Rising interest rate are certainly helping to lower inflation, but will they eventually push the US economy into a recession. Based on the historical evidence, avoiding a downturn in the economy will prove to be difficult.

In the past 50 years, every time the Fed responded to periods of high inflation with rate hikes, a recession soon followed.


But one thing that is not predictable is a US recession – it’s the same every time.

It has just 2 very simple variables – how long it goes for and how deep it hits – that’s it... AND – we all know what happens when a US recession ends – Green shoots everywhere, a resurgence in the economy and a booming stock market – where many of the stocks that have been hammered -50% or -70% stage extraordinary recoveries.

In fact, if you can – stay 100% invested right now (make sure you also have besides the blue chips – some (beta/growth) vis small caps, tech, growth, China plays, resources – and then simply take a year off and don’t look at any stock prices (or kill all contact to the outside world) – and I can (almost) guarantee (from what I have seen in the last 35 years) that your portfolio in Jan 2024 will be substantially higher.

Ok if you can’t do that then you will have the ride out some volatility.

As a US recession gets closer the “market” will selloff – BUT how far is really the only question – in fact “the most important question”

We have seen with the China COVID Zero story late last year – that as BAD as things looked in China – the “market looked through it”.

So this is why I think we have seen a “full dress rehearsal” of how markets may move in 2023 despite a US recession.

With all that we also will be seeing Inflation tamer and possibly the US FED slowing / or even cease rate hikes in the next 3 months.

If and when a US recession hits – and say we see US unemployment only goes up slightly and they have (what most now expect and is has been one of the big reasons for the unexpected US market bounce) --- just a milf recession!

... or no recession

I'm still amazed that Goldman Sachs are saying a 75% on no recession, that will
send shivers down the backs of many. That would really create a bad year for the Bears, the shorts and those in cash.

Then I think markets will not collapse to -30% that a few big brokers have been calling – but instead only drop maybe -10% (but it may only be -7.5%) as the markets will “look through it”.
The most bearish US strategists are looking for falls of -25% to -30% from the Jan highs – but will it go that far?

There will be some sort of selloff– now those who will be sellers are likely to be the recent “retail army” who have been huge buyers and maybe some of them have what could well be the “last panic selloff” (which I might add we have still not seen yet and all the “Veterans” in the market are still waiting for) – that sees short sharp final capitulation by some.

But there is a problem (and it’s a big one). Many are “too long cash” and as a result some will be forced to “break ranks" when market falls. 

Ok I’ve seen this many many times in the last 35 years – investors who were patiently waiting for a huge fall and overweight cash / underweight equites finally see the market fall.

Now they were convinced that it’d drop, say -20%. But the previous drops were not as bad and it then rallied back (bear market rallies) and they missed it (and it hurt their performance).

So this time when we see the US market down say -7.5% to -10% many will no longer sit back and wait for the “big drop” – they cannot risk it if it then goes straight back up.

So they buy the selloff at say 7% just in case BUT others who are also scared from missing the previous selloff also do the same.

The result is that we see higher lows (as we saw in 2003/2004 and more recently in March 2020 on). 

Get more insights from the insto desk in the Coppo report

This article is an excerpt from The Coppo Report contributed to Livewire by Richard Coppleson, Director - Institutional Sales and Trading, Bell Potter. You can find out more here.

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Richard Coppleson
Director of Institutional Sales and Trading
Bell Potter

Richard authors “The Coppo Report”, a highly regarded market newsletter. He has over 30 years’ experience in financial markets, beginning his career at Ord Minnett where he worked for 15 years, before moving to Goldman Sachs.

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