Asian stocks are off to a muted start after a dip in US shares amid concern the recent rally had gone too far. Even after the ECB fired off a policy bazooka, stocks struggled for traction as the S&P 500 suffered its first loss in five days, though the Dow ended mostly flat.
Has pre-NFP sticker shock set in?
A gnarly US NFP is likely to herald the highest unemployment rate since the Great Depression. So, given the magnitude of scintillating equity market moves of late, arguably overextended bullish positioning has likely forced a few hands.
Sharply rising unemployment and rallying equity markets perhaps best underscore the disconnect between stocks and the real economy. It’ll be hard for the US employment report for May (cons: NFP -7.5 mn; unemployment rate 19.1%) to shock markets, given the nonplussed reaction to recent labor market data. Still, the sticker shock of near-20% unemployment suggests US equities may need a rapid recovery in the critical job metrics to justify these elevated levels, let alone for stocks to punch higher.
While it’s entirely possible investor fatigue is setting in, it’s also clear people are starting to look outside of US equities for yield. For me, that’s one of the things to watch as it could signal the end of the rally is near.
Although equity trading pads are busy, US cash-equity flows have been relatively balanced across purchases and sales for the past week. The catch-up to US market gains in EU and EM equity markets is suggesting that those few bullish stock market participants are reaching out for risk and return in other markets beyond US stocks.
ECB: Big Bold and Beautiful
"Big, bold and beautiful" for the Euro is how the market sees the ECB policy. The ECB on Thursday delivered a bigger-than-expected stimulus package – an increase of PEPP by €600 bn to €1,350 bn, and an extension of the program until mid-2021. The ECB has moved well ahead of the curve absent a severe escalation of the corona-crisis.
Calling a top is a mug’s game
However, I still think calling the top is a mug's game with the Fed and the ECB papering the ticker tape green. Liquidity supports risk assets as stimulus impetus becomes too hard to fight, although skepticism remains high on the critic's list for a rapid return to economic normalcy. The words 'capitulation' and 'melt-up' are appearing more frequently in the narrative, suggesting moves are starting to cause pain.
The next risk-off catalyst?
Every night this week I’ve been on a call with a former bank trading colleague from Tokyo discussing the next catalyst for a return of risk-off would be. Aside from the second wave of coronavirus, it’s hard to come up with one. But it’s easier to write a list of things the market doesn’t care about right now.
The only thing that came to mind was the US Presidential election: regardless of who wins, it’ll end up being bad for risk markets. Trump's popularity matters less for US equities as investors likely view his presidency as extremely polarising after bearing witness to four years of uncompromising chaos and drama. And that’s the primary reason why you should continue to add gold on dips.
OPEC headlines aside (and in my view the OPEC+ meeting is barely moving the needle), the cross-asset markets are focusing on the broad-based asset price mismatches from economic reality ahead of what could be a sobering -20 % headline print on NFP.
Bullish sentiment could be giving way to the economic realities as oil traders (well, at least this one) are shifting from a sentiment-driven perspective to now poring over this week's data before buying the dip into the weekend’s OPEC meeting. And, truth be told, everything’s not coming up roses.
Crude stocks declined from their recent peak by 2mb w/w and have now been broadly flat for the past month (and >10% above average). However, large builds in product stocks continue, and total commercial shares were up by 19mbd last week alone. Retail inventories are now 170mb (13%) higher since March. The most significant builds are in distillates, up to 51mb (40%) since March, but gasoline stocks are up to 24mb and are (10%) above the 5-year average. So, with the demand rebound stalling for now with weakness in diesel and jet fuel, total product demand is down ~4mbd y/y. It feels like more of a flip of the coin at this stage heading into next week, hoping that next week's product data pivots lower while keeping fingers crossed the Baker Hughes report delivers more well closures.
But with OPEC+ likely to agree to terms, it’s probably worth dipping a toe in as even if the worst-case scenario sets in, you might only need to keep the position in your pocket for a week as bigger US states continue to reopen.
You can join me at 5:30 PM Bangkok on CNBC TV discussing this view.
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Ongoing rate curve repricing and risk asset reaction perfectly illustrate how worryingly reliant investors have become on easy money policies