As I look at another sea of red across the board in equities this morning with sentiment taking another nosedive, the question is what can give markets a sense of hope once more? The selling pressure that has swept across the board with a massive flight to safety has made a huge dent in investor confidence. Markets do not tend to be able to get out of this kind of funk without a catalyst. So what are we looking for? What could be the signals that prompts a turnaround in sentiment? What could prove to be the catalyst that decides that this move is seen not as just part of a new bear market, but is in fact a chance to buy?
There are two key factors that could induce a change in sentiment, whilst there are also two key markets that could reflect this improvement. First of all, at least one of the two key market drivers probably needs to turn around. The US backing away from a September rate hike and Chinese authorities engaging a shock and awe measure could change investor sentiment. This also needs to be reflected in a bottom on key commodity markets: oil and copper.
Will Jackson Hole give us a sign this week? Although Janet Yellen is not at the economic symposium, FOMC members will be. If the speeches of Fed members suggest that the committee is stepping back from a September rate hike, this could help to give the market some support. This could take the boot off the neck of emerging market economies that have come under so much pressure from the strengthening dollar in recent months. Economies that run big current account deficits whilst running dollar denominated debts (such as the Fragile 5: South Africa, Turkey, Brazil, Indonesia and India) have been under huge strain. The Fed stepping back from a September rate hike may just take the pressure off at least for the near term. Fed member Dennis Lockhart has already backed away from rhetoric of a September rate hike and if more members follow this week this could be the lift the market needs.
The Chinese authorities are finally acting as they try to stabilize the equity market sell-off. However, is it enough? The restrictions being put on futures trading and the capacity to short the market is not going to necessarily help sentiment and could in fact do the opposite. The recent actions of the People’s Bank of China to inject 140bn yuan (c. $22bn) of liquidity into the money market via Short Term Liquidity Operations is more of a supplementary measure. The rate cuts (cutting the lending and deposit rates by 25 basis points and the reserve requirement ratio by 50 basis points) that the PBoC engaged yesterday were the fifth such cut in nine months. What is there to suggest this will work where the other four cuts have not? More clearly needs to be done there.
Ultimately though the declines on commodity prices in recent months have been the key concern for investors. The prices of Brent Crude has dropped 38% since its peak at $69.63 on 6th May, whilst “Dr Copper” has dropped 23% in a similar time. Both commodities which reflect the state of global demand need to show signs of bottoming out. Otherwise there is little to really suggest that sentiment for China and global demand is turning. Both markets (shown below) remain in key downtrends. The downtrend on copper has been tested in recent days (as it has also on NYMEX oil too), but as I write this the trends are still intact, which remains bearish for market sentiment.
Below is a chart from BoA Merrill Lynch that suggests whilst oversupply of oil has a part to play, but the key downward pressures come from demand issues (ie. the China slowdown). This is why it is so important that China acts to at least try to stabilize its falling demand. Whether this be through fiscal measures from the government, or some sort of significant (i.e. more so that it has already done) monetary stimulus from the PBoC is needed.
However, could it be that we have we already seen the low? I mentioned a couple of days ago in the wake of the recent nadir on equities that a simple email can sometimes be enough. The internal email at Citi in March 2009 seemed to mark the absolute bottom of the credit crunch market sell-off. Apple CEO Tim Cook’s email that was sent on Monday to Jim Cramer of CNBC which noted that the tech giant was still performing well in China despite the market turmoil, could turn out to be just as momentous. Despite the volatility again today, the DAX is around 700 points off its low of Monday and the FTSE 100 is over 200 points. It could take markets a while the truly settle down, possibly even weeks. But it is possible that the low has already been seen.
The technicals on FTSE 100 and the German DAX got extremely stretched and oversold on Monday. There were volume spikes on several major indices, as the FTSE 100 had its highest volume since June 2012, and the DAX Xetra saw its biggest volume since March 2013. Major market turning points will often be seen on big volume as a sense of an exhaustion move takes hold. According to my Reuters chart also, on Monday the RSI on the FTSE 100 was the lowest since the huge 1987 low. Furthermore, on a shorter term basis, the technical volatility on the DAX has reached extreme levels as the market traded entirely outside its Bollinger Bands on Monday, a signal that suggests there is a set up for a potential bottom.