Who will be King – Fundamentals or Technicals?

Looking at equity markets at the beginning of the new year, specifically the S&P 500 as the most followed benchmark, I see an interesting divergence between the severely negative technical state of the market and the largely sound fundamental environment which only shows partial deterioration. Which side is likely to win the battle? Are technical indications a sign of something around the corner, that we just don’t know about yet, or is the market overreacting temporarily to worsening fundamental conditions?

Why was the drop so unexpectedly sudden and deep?

In my opinion, this was due to a pivot in investor expectations. Suddenly, after investors judged the environment to be perfect throughout 2017, economic deterioration was priced in with a strong possibility to further decelerate and lead into a recession.

This is the big question we face right now: is the market as a whole smart enough to foresee such a development correctly or did investors overreact and change their expectations more than was warranted?

Unfortunately the answer to this question is essentially unpredictable and only the future will show which path we actually take – it is simply not set yet, but dependent on a multitude of possible decisions by policy makers and other market participants that will influence the outcome.

A good image to illustrate such an unstable tipping point is that of a balanced scale, that may tip to one side or the other – often caused by seemingly minor, unforeseeable occurrences.

Financial markets are an inherently uncertain environment and we need to concentrate on shifting probabilities in our favor, while protecting our portfolio from unlikely worst case scenarios.

How to deal with uncertainty?

We can, however, develop a meta strategy to help us navigate such an uncertain environment successfully. Stay tuned for the next couple of blog post outlining a model to gradually adjust exposure across a portfolio of assets and strategies using quantitative analysis of the market environment – both from the fundamental and the technical side.

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