Market bounce starts to fade as volatility remains the bogey man of the financial system

Financial markets started the day on a high at the end of the week, however, some gains have been lost as we move towards lunchtime during the European session. The FTSE 100 had been up more than 5% at one point, however it is now up around 2%. In the new normal that we live in, stocks are struggling to hold onto gains so the prospect of these gains being the start of a big recovery remain slim. 

Looking at the FTSE 100 in depth, the stocks that are rising at the end of the week are some of the companies that have been hardest hit by the coronavirus-induced sell off. Carnival, the cruise ship operator, EasyJet and JD Sports have seen double digit increases today. This is a sign that the markets are starting to react to the level of central bank and government support being offered across all sectors of the economy and to individuals to protect them during this time of unprecedented global economic shut down. The latest developments include an ECB package of loans and support worth more than 800bn euro, a dramatic interest rate cut from Norway and more commitment of billions of dollars from the Federal Reserve to ensure that there is not a funding crunch across the world. However, will it be enough? 

What next for financial markets when capitalism is in freefall 

While stock markets are reacting positively today, will the official support to protect financial markets be enough for tomorrow? We have never been in a situation before when governments across the world have acted in unison to supress global GDP for an unlimited amount of time. Every sector is impacted, most negatively, while only a few will survive. One hopes that those sectors who do thrive supermarkets, healthcare providers and medical equipment makers, will avoid the urge to put up prices when demand is surging. Essentially, the free market/ capitalist system is also in freefall along with financial markets. The latest headlines suggest that social distancing measures in the UK may need to last for most of this year, how do markets price in the impact? The truth is, they can’t. This will inevitably lead to disruptive and dysfunctional financial markets for the long haul. 

Volatility isn’t going away. This is the time when central banks and governments will see the strength of their finances and the intelligence of their decisions. Business media also has a role to play – alarmist headlines and quotes from shady sources such as ‘government advisors’, need to be nipped in the bud. If you are trading these markets and trying to jump on the short-term trends then you need to be very aware that a stray news headline, potentially produced by an inexperienced junior, could put the boot into your position. 

Markets look for a medical solution to a financial crisis 

Right now, the only thing that will calm markets, tame volatility and lead to a prolonged recovery across risk assets will be a medical solution to the coronavirus. The minute governments announce a vaccine, then we would expect markets to engage in a sustained rally. However, the long term economic damage that will be done over the coming months, which is also necessary to flatten the curve of new cases, could mean that the recovery may not be V-shaped like we had expected a few weeks ago, right now we are looking at a U-shape, and in the worst case scenario even an L-shaped recovery, which is what the naturally pessimistic markets are pricing for. Below we take a look at individual asset classes: 

Equities: Global indices are in recovery mode today, with the Eurostoxx index leading the way. However, indices are giving back some of their early gains. European stocks are looking to the US for guidance. Any new announcement from the Fed or the US government is likely to the key driver of markets in the short term.  In this environment there is no point in doing detailed technical analysis. Key levels are not being respected. If anything happens that could jolt volatility higher, equities are likely to fall. Any weakness in supermarkets and healthcare/ pharma companies may be bought into, likewise, any strength in airlines, discretionary spending sectors and holiday firms could be used as an opportunity to sell. Do beware that there could be forced selling in the coming weeks, as big institutional names are forced to sell and move into dollars. 

Government bonds: gilt yields have fallen sharply in the UK, with the 10-year yield at 0.5%. The emergency rate cut from the BOE on Thursday flattened it further and calmed some investor nerves that bond yields were starting to creep higher. On Friday, Treasury yields also crept a touch higher, the 10-year US Treasury yield was back above 1%, as risk sentiment improved. Right now, the risk is to the downside for yields. We don’t think that investors will ditch the safety of government debt until there are signs that a vaccine is on its way.

FX:The dollar is king, just not today. The pick-up in risk sentiment has pushed GBP/USD back above $1.17, and the dollar is lower across the board. While we believe that the pound’s sell off was unjustified, GBP has traditionally been a volatile currency, and we may see further declines. We just can’t believe that the dollar won’t remain in favour for the foreseeable, regardless of what the Fed does. 

Commodities: Crude oil remains vulnerable, it attempted to climb above $30 per barrel today (Brent crude), however, it has given back most of those gains and is currently only 0.3% higher on the day. In an economic shock, one with no end in sight and no tested recovery plan, it is hard to see oil rallying. While news that President Trump may step in to try and resolve the Russia/ Saudi Arabia oil spat boosted oil earlier today, price action suggests that this spat is the least of an oil bull’s worry. Instead enforced global economic stasis is keeping oil subdued for now, $25 is the next level to watch in Brent crude.