It is a sea of red, and interestingly, Australia showed once again yesterday that when we see turns in market sentiment it often starts from this little corner of the world. However, the moves we saw in Asia yesterday built through Europe and into US trade, and despite an ugly session yesterday, we’re likely to see dark and sinister open for Asian equities today, with Aussie SPI futures -3% and Japan and HK just over 2%.

Second wave concerns

Fears of a second wave, specifically in a number of the red states in the US were making waves around markets yesterday, and the fact that Steven Mnuchin has reiterated (overnight) calls that there will be no further shutdowns makes some feel a little vulnerable. There is increased focus on Arizona state which is going into high alert, but Florida and South Carolina are also getting attention and are worth watching for its case count.

Some have pointed to the Fed’s economic projections as a source of the reversal, which effectively took a V-shaped recovery off the table, and there is some merit to that given markets are priced so rich that they need new news that is going to knock it out of the park to push this risk juggernaut higher. But, at the helm and the reality of the situation is a market that has been pushed to a limit, where the participation in the rally has become ever more concentrated and poor breadth is absolutely the key issue here. We’d seen sector rotation after rotation, all the signs of a healthy market, but with the clear benefit of hindsight, we’d got to a point where the elastic band had just been primed a little too far.

A huge move in equity vol

One factor that jumps out is that implied volatility has come alive, with options pricing implying ever-larger degrees of movement. The VIX index has lent on the 200-day and used it as a springboard to push to 40%, gaining 13 volatilities on the session – this implies a 2.5% daily move in the S&P500 (higher or lower). There has been a massive shift across the VIX futures curve, with traders hedging downside risk and buying volatility in the next few months and it’s not even that cheap.

Once bitten twice shy and this market is genuinely worried about the consequences of a second wave.

In terms of cash equities, the S&P500 was taken downtown, with a 5.9% fall, the worst day since 16 March, to settle just above the 3000-handle. Turnover was 28% above the 30-day average and 99% of stocks were down on the day. Close to 3.5m S&P500 futures contract traded hands, the most since the 12 march, with price settling back below the 200-day MA. The Russell 2000 has been smoked by -7.6%, while the NAS100 closed -5%.

Obviously, the question on the floor is whether the second wave fears will be sustained, in which case we need to consider what exactly that looks like and how markets could be affected – or is this just another buying opportunity.

As goes the S&P500 as goes risk FX

The moves in FX were also punchy, but as detailed yesterday, if the S&P500 tracks lower than names like the MXN, CAD and AUD will be sold. I put EURCAD on the radar, and this is working well and feels like this could squeeze into 1.5530 near-term, especially with crude rolling over in such aggressive fashion. Not sure I really need to offer too much colour in FX other than where the S&P500 goes, the path of risk FX will follow.


Published by Chris Weston, Head of Research, Pepperstone