What are the best bear market trading opportunities?

Which asset classes offer trading opportunities in a bear market?

The coronavirus has emerged as the new risk off market catalyst in 2020, wreaking havok accros asset classes, causing central banks to abruptly relook at the paths of monetary policy.

In this article we look at how the market correction has evolved in to a short term market crash, pushing a number of key markets into or close to bear territory.

Global indices

The below graph shows major indices across the world, referencing their current prices (as of 9 March 2020) relative to their yearly (52-week) highs.

The China A50 shares index is the best performing of the indices covered, trading around 11.25% off its yearly highs. The irony is that the index which is outperforming is also representing the economy in which the coronavirus outbreak originated and is most severe.

The People's Bank of China (PBOC) has started to embark on a number of stimulus measures including dropping the medium-term loan facility for banks, cutting benchmark lending rates and a large (more than 1 trillion yuan) liquidity injection into market. Further reason for Chinese indices to be outperforming its international peers (although still trading negative territory) is the regions ban on short selling by officials.

European indices, the Italy 40, Ibex 35 (Spain), CAC 40 (France), DAX (German) and FTSE 100 (UK) indices all trade more than 20% off their respective oneyear highs. A move more than 20% from the high, suggests the markets in question to be in a technical bear market. Italy is the worst performing of these markets, not coincidently, it is also the country with the highest number of coronavirus fatalities outside of mainland China.

The Brazilian Bovespa trades in bear market territory as well with fellow emerging market peer the South African Top 40 index trading very near thereto.

With major US indices the Nasdaq, S&P 500 and Dow Jones industrial average all having declined in excess of 17% each (since the all-time highs realised just this year), and despite renewed monetary easing (50 basis point cut), the suggestion is that these markets could enter bear market territory soon.

The relatively high correlation in equity markets we have seen, highlights a fear still prevalent in the global market place, with selling becoming almost indiscriminate. While many will question the validity of fears stemming from the coronavirus, the supply chain and in turn economic disruption cannot be denied. The uncertain length of disruption which is increasing in its reach continues to discount into the market place.

How to trade global indices

It is likely that major indices could experience a sharp rebound from what appears to be severely oversold territory at present. A rebound can be caused by several factors including new central bank action (possibly the European Central Bank [ECB] next).

However, trend followers might look to a rebound as an opportunity to re-enter short positions in the market in anticipation of new near-term lows to follow.

For now, we feel like the high valuations in equity markets have not yet been fully discounted, particularly when we consider the unknown adversities from the economic disruption at present. Monetary stimulus can support markets but not fix the supply-chain issues prevalent for now.

Major commodities

The below graph shows major commodities, referencing their current prices (as of 9 March 2020) relative to their yearly (52-week) highs.

China, the world’s largest importer of oil has been the primary demand side concern for the oil market amid the coronavirus outbreak. But while demand for the commodity has been under question, the supply side is now a bigger concern for the commodity after comments from Saudi Arabian officials that they would look increase production by 10 million barrels per day. The Organisation of Petroleum Exporting Countries (OPEC) have been curbing daily production by as much as 2.2 million barrels per day. Expectation was that OPEC would be looking to further cut production not increase it, and certainly not as substantially as has been suggested.

The announcement is a direct U-turn on the supply curbs currently in play. The move is said to be a price war with Russia who appeared unwilling to support further OPEC supply curbs as it assesses the impact of the coronavirus on demand. The move is also said to be an attack on US natural gas (extracted from shale rock formations) used to generate energy in the US, including (more specifically targeted) oil.

As an increase in Chinese quarantine zones disrupt manufacturing production activity, base metal prices are feeling the pinch. China imports roughly 45% of the world’s copper (which is 16% off the 52-week highs) and more than 65% of the world’s iron ore. The Chinese economy is now expected to, at best, grow at around 1% in the first quarter (Q1) of 2020, which would be its slowest quarterly growth realised on record.

How to trade major commodities

The more than 20% single day drop in crude oil appears to be an exaggerated shock move. Should Russia and Saudi Arabia find some accord it could mean a far less aggressive supply increase being brought to market. It does, however, appear likely that the supply to the market can increase amid uncertain future demand. This could be more negative for natural gas markets than for crude markets which haven’t yet corrected as far as oil prices have.

Gold appears to have reawakened as a safe-haven asset and traded back to multi-year highs. The trends appear firmly up and a short-term pullback could provide long opportunities for traders.

Major forex trends

The below graph shows major currency pairs, referencing their current prices (as of 9 March 2020) relative to their yearly (52-week) highs.

The movements in the forex market show some obvious trends right now. Commodity driven economies such as Australia and Canada are seeing their respective currencies under significant pressure as the demand side wanes for oil and metals. Both the Australian and Canadian central banks have moved to cut lending rates unexpectedly in the last week or so, an admission to tough economic conditions present and expected.

The Japanese yen and Swiss franc have produced strong gains against a broad basket of currencies. This serves to evidence these currencies preference amongst investors as safe-haven assets.

How to trade currency moves

As long as traders consider the risk to be elevated in the market place with supply side of commodities expected to exceed the demand side thereof, looking for short entry into the AUD and CAD against safe havens such as the JPY and CHF will continue to find appeal.