Head of Equity Strategy
Summary: S&P 500 was down 5.9% yesterday as the VIX Index exploded above 40 in its biggest daily jump since 16 March. Many explanations have been given but many factors likely contributed and created the right feedback loop. However, the lesson learned yesterday is that the rally the past 10 weeks have not alleviated fragility in financial markets and that sharp declines can come out of the blue. We also touch in today's equity note on earnings from Lululemon and Adobe.
Yesterday’s session was an interesting one for many reasons. S&P 500 was down 5.9%, the VIX Index exploded higher to 40 and US small caps were down 8.2%. Many explanations were given from retail traders getting hit on their margin positions, to the Fed’s dim outlook presented the day before the selloff and uncertainty over a second wave of COVID-19 in the US. Maybe the selloff was a mixture of it all, but the lesson learned here is that this market will continue to be volatile and tight risk controls are important for traders. We have likely hit the ceiling for now and from here on it will be more wobbling as the Q2 earnings releases hit the market in a month’s time. It was also
Regular readers will know we have often highlighted the 22 level in the VIX which is generally in the industry to be the long-term equilibrium in the term structure. In other words, this is the threshold where the market flips from being bullish (positive returns and low volatility) to bearish (negative returns and high volatility). The VIX Index broke above 22 on 24 February and has stayed above this level ever since. While the US equity market recovered the losses from February and March the implied volatility market never really gave investors the signal that the bear market was over.
With the VIX Index settling above 40 yesterday the bears have got new ammunition and the market will stay fragile over the summer with high volatility as the Q2 earnings releases will reveal the damage of the corporate sector. But maybe even more importantly a potential outlook so investors are not flying blind any longer.
Outside yesterday’s carnage in US equities we got terrible earnings from Lululemon which was hit hard in the previous quarter from closed stores. Despite e-commerce sales grew 125% in April it was not enough to avoid revenue declining 17% y/y for the quarter. Adobe on the other hand showed the market why it’s a darling of Wall Street beating earnings estimates and delivering on revenue growth as its pure digital offering was immune to the global lockdowns due to COVID-19. IPOs and other deals have accelerated from March lows in tandem with rising equity sentiment and Palantir just announced that it’s filing for IPO next week. This is one of the most anticipated IPOs as the company is perceived as being the frontier in terms of big data analytics on the application side.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
