The first real ‘buy-the-dip’ test in 11 months

The first real ‘buy-the-dip’ test in 11 months

Equities 8 minutes to read
PG
Peter Garnry

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.

Source: Saxo Group

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.

Source: Saxo Group

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.

Source: Bloomberg

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.

Source: Bloomberg and Saxo Group
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Saxo Markets
Most of our staff in Singapore are working from home to help limit the spread of the coronavirus. We remain at your service on the details below. Thank you for your understanding.

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.