There was nothing really new coming from the US Fed this week, both in terms of monetary decisions and economic forecasts... which seemed to be enough on the surface to trigger the first major profit-taking in the markets since early May. Back to a turbulent trading session, with a closing bell that sounds like a return to reality.
A Technical Correction
- The bull market trend of the last few weeks finally ended yesterday without a strong catalyst:
- In the United States, the indices dropped an average of 5-7% on Thursday 11 June;
- In Europe the stock markets fell around 4% yesterday;
- Equity volatility rose significantly to levels not seen since the end of April;
- In terms of sectors, we are seeing a reversed rotation - the stocks that had risen the most in recent weeks are losing the most ground (Industry, Energy, Banks, cyclical consumer spending);
- Some equity markets are resisting better. Asia’s opening this morning showed stronger resilience, and in particular Chinese equities which are almost stable;
- Gold is back above USD 1,725/Oz while oil (WTI) is down 8.66%;
- Credit spreads have widened, as evidenced by the Itraxx Crossover index, which has risen by 25 bps.
- Government bonds have seen a flight-to-quality movement (their yield has fallen by 6-8 bps) from their already low yield.
A number of technical catalysts partly explain this correction, factors that we identified last week:
- Markets having recovered a significant part of the February/March correction (two/thirds for the Eurostoxx 50 and almost all for the S&P 500), and returned to high valuation levels;
- Important technical thresholds had been reached, notably the 200-day moving averages on the Eurostoxx 50, which played a resilient role for the European equity market, has now fallen back to the 100-day moving average;
- Other technical indicators also mentioned in our note of 5 June, such as RSIs are in the zone above 70, a level often correlated with the triggering of a technical correction;
- A put/call ratio on the option markets which was in euphoric territory and may show that part of the rise in equities over the last month was via buying of calls, whose gains were significant but can erode rapidly. This may have accentuated the profit-taking observed during the session;
- The rise in equity volatility has also played a role in accentuating the selling pressure on markets.
At the macroeconomic level, it is not easy to identify a unique explanatory factor, but the week's news was punctuated by mixed signals:
- An OECD report more pessimistic than the IMF projections in April, pointing to a global recession of 6% in 2020;
- A Chinese trade balance showing a low level of imports (-16.7% year-on-year, well below expectations), which suggests a still partial rebound in activity, even if the effects linked to raw materials (metals in particular) are undoubtedly important in this drop in imports;
- US employment, whose statistics show a continued decline in new weekly unemployment registrations (around 1.5 million over the previous week compared with an average of 2 million the previous two weeks), but with the number of jobless registrations continuing to fall, while remaining at a level as high as 20.9 million.
The US Fed’s meeting marked a turning point or at least a pause in the market trend, despite the lack of announcements:
- Investors had no expectations of further action regarding this meeting;
- The key issue at stake was the Fed's updated economic forecasts;
- In this respect, the expected path of inflation persistently below the target is a guarantee of the durability of its very accommodating policy, with rates expected toremain close to zero until at least 2022;
- Furthermore, the forecast of -6.5% growth in 2020 followed by a 5% recovery in 2021 does not come as a major surprise compared to the scenario already anchored since mid-April;
- Several Fed members had already expressed their views on a trajectory of a fall in unemployment to below 10%, so the projection of 9.3% by December 2020 is not a surprise either;
- On the other hand, a very cautious tone may have prompted investors to take profits, considering that much of the news was now fully priced-in. Does this correction mark the entry into the second part of the W-shaped recovery already discussed?
Does this correction mark the entry into the second part of the W-shaped recovery already discussed?
- It is probably still too early to tell, as it is difficult to identify catalysts for a return of markets to the March lows, at a time when our economies are exiting lockdown, market liquidity has normalised and support measures are significant;
- It is also possible to put this correction into perspective, since it’s still very short duration and moderate size (7% cumulated on the Eurostoxx 50) make it comparable at this stage to the correction in early May;
- But the magnitude of the day's fall and the sharp rise in volatility point to a more significant correction, which may quickly bring the Eurostoxx 50 back to between 2’900-3’000 points and the S&P 500 to between 2’800-2’900 points, levels to be monitored that may provide a support zone for the markets.
In the short-term, we therefore expect a limited technical correction rather than a new capitulation.
In the medium-term and more broadly, after a phase of optimism driven by the joint action of central banks and governments, investors are refocusing on the strength of the recovery, the risk of a second wave of coronavirus infections, and the rising political risk between the United States and China. This summer could also mark a rise in tensions around Brexit in the absence of a convincing breakthrough in the negotiations, the deadline for which will probably have to be pushed back, but investors have become accustomed to this over the past four years. On the other hand, the upward trend in unemployment that we expect in Europe over the next few quarters could weigh on consumption.
In conclusion, we expect this return to the reality of a gradual recovery in activity to have a greater impact on the markets than the now well-integrated economic policy measures.
June 12, 2020