The trembling’s of the world’s stock markets turned into a rout overnight, with the major Wall Street indices all tumbling by between 5 and 7%. It is essential to understand why this happened to gain clarity about what the future may hold.
One of the worst habits that the collective hive wisdom of the financial markets has, in this day and age, is fitting news headlines to the chosen short-term narrative. That habit was in full cry overnight, with global hand-wringing that secondary outbreaks of COVID-19 in the United States would send the world into an economic tailspin. That premise is entirely incorrect for one simple reason. The United States, through a combination of complacency and incompetence, had never got the initial outbreak under control, they were still in wave one.
Admittedly in places such as the State of New York, aggressive lockdowns had seen progress made at the cost of huge body counts. Much of the rest of the country though, engaged in measures half-heartedly and continued in a state of blissful denial. I cannot remove the recent picture of thousands of Americans crowded on a bridge to watch the Space-X launch from my mind.
Treasury Secretary Steve Mnuchin stated overnight that closing the economy again was a non-starter, as the economic price was too high. That means that the United States is taking a similar position to other developing countries around the world, growth over graves. On that basis, investors who have loaded up on airline shares should think again, and quickly.
An Aggressive Bull In the Making?
The real reason we are now in the midst of what could become, a quite aggressive bull market correction in global asset markets, is simply the weight of bullish positioning in the market. The price action on Wall Street overnight highlights, in my opinion, the amount of Johnny come lately fast-money positioning that has piled into stock markets looking for a quick buck. As I mentioned previously, bullish option positioning on the S&P 500 had hit record highs, another leading reverse-indicator warning sign. Herd mentality, fear of missing out and shallow pockets, not economic downgrades, dovish central banks and secondary outbreaks of COVID-19 are the simple underlying causes of the falls seen in the past two days. That is merely fitting headlines to the chosen narrative of a crowded trade.
COVID-19 and Jay Powell’s “jobless recovery” are "known unknowns". What is a "known known", is that the world’s central banks will keep the zero-percent monetary spigot fully opened for at least the next two years. The Federal Reserve will keep backstopping otherwise idiotic investment decisions for the foreseeable future, meaning an ocean of money will continue looking for a home in a zero per cent world. That is the main reason that asset markets have risen Phoenix-like after the mid-March capitulation. That is the reason that once the aggressive social distancing being imposed on financial markets has passed, it will do so again.
The only way this thesis will be negated in the author’s opinion, is if secondary COVID-19 outbreaks force new national lockdowns across developed market economies. A point I have made repeatedly.
The data calendar is light in Asia today, but mostly meaningless as the exit of the herd from the global FOMO trade in equities continues.
US stock futures limit the fall-out amongst Asian equities
Wall Street equities cratered overnight as the fast-money, get-rich-quick crowd were given a harsh dose of reality. The S&P fell 5.90%, the NASDAQ dropped 5.20%, and the Dow Jones fell 6.90% in an ugly day for world stock markets. To give some perspective though, on a monthly basis, the S&P 500 is still up 7.40%, the NASDAQ by 7.10% and the Dow Jones by 9.0%. Wall Street has substantial room to ease further and still only be in a bull-market correction.
The S&P 500 is in danger of closing below its 200-day moving average (DMA) at 3034, which likely signals a deeper correction. That said, the NASDAQ remains around 1000 points above its 100 and 200 DMA’s, emphasising that a bear market is both distant and unlikely.
Aftermarket US index futures have rallied this morning though. The S&P500 E-mini well over 1.0% higher in Asia thus far, as are the NASDAQ and Dow futures. The rally in US index futures is almost certainly driven by profit-taking from short-term traders. Nevertheless, it has served to limit the fall-out from the Wall Street rout overnight, spilling aggressively into Asian stock markets.
But fall-out, there has been, with Asia a sea of red today. The Nikkei 225 is down just 0.65% as the Japan Government clarifies its stimulus measures. Export-centric South Korea is 2.65% lower though, with the Shanghai Composite and CSI 300 down 1.10%.
Regional Asia has seen manageable falls. Singapore, Hong Kong, Jakarta and Kuala Lumpur all down around 1.50%. Australia has not fared as well, the lucky country being one of the epicentres of the global recovery FOMO-trade. The ASX 200 has fallen 2.90%, with the All Ordinaries down 3.40%.
The resilience of Asia will be a relief to many but is entirely reliant on the US stock futures holding onto their gains in after-market trading. Europe also fell heavily overnight, but if the present status-quo holds in Asia, the fall-out should be modest when they arrive this afternoon. All eyes will be on the US this evening and whether the correction continues or is forgotten as quickly as it began. A sensible case can be constructed for either outcome and a wait and see strategy is the best one.
Once again, I will emphasise that given the scale of the rally from the mid-March lows, global stock markets have a lot of room to correct lower without changing the underlying premise; central bank money pumping up asset valuations.
The US dollar rebounds on haven buying
Another, less noisy, culling of a crowded trade occurred overnight, as the US dollar recouped some of its recent losses as stock markets tanked. The US Dollar and its fellow haven currencies, the Swiss franc and Japanese yen, all outperformed as short-term investors rushed for safety.
The EUR/USD fell by 100 points to 1.1285 overnight, narrowly avoiding an outside reversal day with its very negative technical implications. That said, such has been the Euro’s gain in the past month, only a fall through 1.1000 would negate the overall longer-term technical picture.
Having failed at 0.7000 on multiple previous days, the Australian dollar had a terrible day at the office. AUD/USD fell 2.0% to 0.6845 and could now correct as low as its 200-DMA at 0.6640. AUD/JPY, a popular risk proxy, fell by 2.30% to 73.50, with a test of its 200-DMA at 72.25 likely. All of the commodity currencies were singled out for tough love overnight though. The US dollar index finished 0.80% higher at 96.73.
Asia saw the dollar rally continue initially, with regional Asian currencies and the AUD all sinking again. The rally by US index futures and the stabilisation of Asia’s equity markets have seen those losses quickly erased though. Major and Asian regional currencies are now almost unchanged.
The short-term direction of the regions stock markets and US index futures will dictate the direction currency markets will take in the near-term. Forex traders are content to play follow-the-leader to equities. Another massive sell-off by Wall Street this evening though, will see US dollar gains resume with renewed vigour.
Oil prices follow equity markets South
As one of the most pumped-up recipients of the peak-virus global recovery trade, oil was never going to escape a fall-out in equity markets. The hordes of short-term bullish positions in oil were unceremoniously locked down overnight, Brent crude falling 7.50% to $38.30 a barrel, with WTI also down 7.50% to $36.20 a barrel.
While the retreat by oil looks more like a culling of an overly crowded trade, Brent crude did close below its 100-DMA at $38.65, a bearish technical development. Should the rout in equities continue, Brent crude could extend its losses to $37.00 a barrel, and possibly as far as $33.50 a barrel.
WTI, on the other hand, narrowly avoided the same fate. It was closing just above its 100-DMA at $34.00 a barrel. A failure of that level implies further losses to the $31.00 a barrel region.
Both contracts probed the downside this morning, before recovering to an unchanged level, saved by the rally on after-market US equity futures. The short-term direction of oil is intrinsically tied to them now, as are Asian equities and currency markets. Looking ahead, the long-oil trade had become a very crowded one with zero social distancing. The failure of Brent to completely close its price gap above $40.00 a barrel was a warning shot we all ignored. Further losses to cull nervous longs are a real possibility, and a certainty if Wall Street falls this evening.
Gold disappoints haven buyers overnight
Last night should have been gold's chance to shine, as risk aversion swept pandemic-like across other asset classes. Instead, gold found itself dragged lower by falling equity markets, with gold positions liquidated to cover losses elsewhere. Gold fell 0.70% to $1727.00 an ounce, as haven-buyers were swamped by the margin-call sellers from the stock market.
What seems clear now is that gold cannot disengage from equities in a panic sell-off, but is left to its own devices in a bullish market. Panic-liquidations elsewhere will lead to panic-liquidations of gold as well. It also highlights my previous warning about going long at the top, or short at the bottom of gold’s multi-month $1660.00 to $1760.00 an ounce range.
A topside break of the monthly rage is highly unlikely in these circumstances for now. Gold is unchanged in Asia as equity-related sellers balance haven buyers. Gold seems likely to continue to frustrate "inflationistas'" bullish hopes for some time to come.