The first real ‘buy-the-dip’ test in 11 months
Head of Equity Strategy
Summary: In today's equity update we sum up a hectic trading session seeing a steep selloff in global equities driven by concerns over Evergrande which will hit judgement day on Thursday with two bond payments due. We argue that the selloff was long overdue driven by a self-reinforcing 'buy-the-dip' winning strategy that had caused a strong rally with low drawdowns. It was unsustainable and now the Chinese housing market situation became the excuse for selling equities. The question is now how deep we can go in S&P 500 futures?
For over a week I was on the telephone with journalists talking about Evergrande and whether it could turn out ugly for global financial markets. I kept arguing that under the reasonable assumption that financial markets are efficient there were few signs that Evergrande had the potential for global contagion. But what if nobody has seen it coming was the quick follow-up question. Well, financial markets consist of millions of professional and retail investors analyzing markets, and their judgement has been so far that this is a Chinese self-contained problem. Even after today’s heavy selling in equities, credit markets in the developed world is barely budging.
China has the ressources to manage a deleveraging of its housing market
While the six largest Chinese real estate developers have interest bearing debt worth $291bn and total liabilities of $1.06trn, it is still manageable for the Chinese government. China managed the NPL crisis of large Chinese banks in the 1990s and this potential crisis is on the same scale. China’s credit market and housing market is not interconnected enough with global financial markets to cause a contagion effect as far as I can see and judging from market reaction. If China does not succeed in a controlled deleveraging of the housing market and an orderly nationalization of failing real estate developers then it could severely cut into the growth outlook which is negative for equities and global growth, but we are not talking about a new global financial crisis. The current energy shock in Europe, which we wrote about last week, makes us more nervous as it has the potential for knock-on effects into 2022 hitting food supplies and prices.
Biggest selloff since October 2020 and VIX jump
Many have pointed to the fact that the 50-day moving average has been broken. I subscribe to the view that it is a random number – why not the 48-day moving average? But technically, the 50-day moving average has been the area when S&P 500 futures have bounced many times since October last year and thus require some more analysis. As of this writing, S&P 500 futures are 2.3% below their 50-day moving average, the biggest spread since October last year, and given the success of ‘buying-the-dip’ over the last 11 months the question is whether the cavalry is coming again. It is quite clear in today’s session that the last 20 minutes of the cash equity trading session has attracted the ‘buying-the-dip’ crowd given the sizeable 1.3% bounce into the close.
Financial markets are like a biological system with its own evolutionary dynamics. The constant rebounds at even the smallest dips in equities have steadily become a reinforced winning strategy adding more dollars behind it. The MSCI World Index was as of last Friday in a rally over 229 trading days without a drawdown of more than 5%. As we warned about already in late August, investors seemed to have become blind to risks given this dynamic and the VIX Index had yet become compressed to historically low levels. VIX is trading around the 26 level around the cash equity close in the US down from the intraday high of 28.79. This level in itself indicates that the sell-off may not be over yet and the market is anxiously waiting for mainland Chinese investors to come back from holiday on Wednesday and Thursday judgement day for Evergrande with two bond payments due.
The distribution of the S&P 500 futures price to the 50-day moving average is very negatively skewed for negative values (when the price is below the average) of this spread. The current -2.3% spread is roughly around the 45 percentile of the distribution and thus we could easily go down a couple of percent more from here, and down 10% from the recent highs if the Chinese housing crisis escalates further with minimal support from the Chinese government. The selloff is amplified somewhat due to the duration of the rally and the way drawdowns have been compressed. However, we remain positive on equities given the fiscal support and current trajectory for earnings, but we are ready to revise our view if inflation shows more signs of becoming more sticky at higher levels.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.