June’s First Dose of Reality Has Markets Searching for Signposts

(Bloomberg) -- Traders are returning to work trying to decipher whether last week’s selloff was merely a blip or something more ominous.

The fact that risk assets just about gathered their composure Friday following the previous day’s nosedive gave comfort to the bulls -- Wells Fargo & Co. and ING Bank NV were among those saying at the weekend that the retreat will be temporary. But the week produced more than enough evidence to suggest the gains of early June might be coming unstuck.

The Federal Reserve’s warnings on the length of the downturn and fears of an economy-crippling second wave of Covid-19 contrived to trigger a rally in the dollar, a slide in bond yields and the biggest rout in U.S. stocks in 12 weeks. Volatility as measured by the Vix Index jumped on Thursday to its highest level since April 23.

“Closing the first half of June, market volatility went through the roof,” said Reem Aboul Hosn, a senior markets analyst at Credit Financier Invest, a Dubai-based trading firm. “The recovery’s timing may not be as optimistic as the markets first thought.”

Middle East markets stuck to the negative theme on Sunday. Kuwait’s main stock index dropped more than 3%, Dubai, Bahrain and Qatar’s gauges lost 0.5%, while Abu Dhabi’s retreated 0.4%.

The following is a round-up of comments looking ahead to a week in markets:

Francesco Pesole and Petr Krpata, currency strategists at ING Bank NV in London:

• “The resurgence of Covid-19 cases offered a motive for some aggressive profit-taking in equity markets after a long rally. If this week was about a physical correction, next week will tell us how solid market appetite is.
• “We suspect that while headlines about second waves in the U.S. may temporarily upset sentiment, risk assets may once again prove resilient, still counting on the Federal Reserve’s printing machine and taking heart from the restart of the global economy.
• “We expect the dollar’s bear trend to start consolidating again next week, warranted not only by some resilience in risk sentiment but also by the now cemented notion that the Fed remains highly committed to an extra dovish stance, and the feeling that it stands ready to pump up its quantitative easing if the stock market comes under severe pressure again.”

Andrew Sheets, chief cross-asset strategist at Morgan Stanley in London:

• “A new cycle has started, and we think that investors should position as such. We think that stocks and credit will be modestly higher and tighter over the next 12 months, but the more compelling opportunity lies in traditional ‘early-cycle’ rotations: smaller and cyclical stocks in the U.S., value stocks outside it, higher yields, steeper curves, a weaker dollar and lower levels of volatility.”

Deepak Mehra, the head of investments at the Commercial Bank of Dubai:

• A second wave of virus infections “is very concerning. The risk is something highlighted by the WHO. And we also had Powell who came to the FOMC talking about his concerns about the recovery. We remain in extremely uncertain times. We haven’t seen so much uncertainty ever before.
• “When it comes to allocation to equities, our discussion with clients is very simple: you cannot come to such an equity market beyond your risk-appetite mandates. So go back to your risk appetite and understand what’s your risk-take ability, what is your experience, how do you behave under stress, and only then take allocations to equity markets.
• “I’ve been bullish on the dollar. It’s just about the relevant position of the U.S. versus Europe and the U.K. that gives us the conviction that the U.S. dollar is the place to be in. Also, if you are going to see more volatility in the future, the risk will continue to benefit the U.S. dollar.
• “Volatility is the name of the game, and if you are a smart investor sitting on cash, you will get opportunities that you missed so far.”

Nick Bennenbroek, Brendan McKenna and Jen Licis, international economists and analysts at Wells Fargo Securities:

• The team “expects further U.S. dollar weakness and foreign-currency strength over the next 12 months or so. In particular, we are more positive on the euro, Canadian dollar, and many commodity and emerging currencies.
• “Foreign-exchange markets have been particularly fluid in the first half of 2020 amid the Covid-19 pandemic and associated lockdown measures, which disrupted activity globally. Going forward, we believe the worst is over for the global economy, and financial-market disruptions should be limited, even if second-quarter GDP declines are still likely to be severe.
• “We believe the interplay between the U.S. dollar and equity markets could be the most significant influence on the U.S. dollar, and one which we believe will weigh on the greenback. In this context, we look for many G-10 and emerging currencies to strengthen over the next 12 months or so, and see overall weakness in the U.S. dollar.”

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