Global risk sentiment slumps, what comes next?

It’s not been a great August for global risk sentiment and for equity indices, which are making a loss for the month so far. Risk sentiment has faded, and technical indicators suggest that selling pressure may continue to build. One of the drivers of this sell-off was the minutes from the Federal Reserve’s July meeting, which said that a majority of FOMC members are prepared to taper asset purchases later this year, rising Covid infections and more lockdowns especially in Australia, New Zealand and Israel are also helping to sour the mood. This has led to a sharp decline in stock prices and commodity prices including Brent crude oil, which fell 1.7% on Thursday and is at its lowest level since the end of May. A theme of the summer has been the fickle nature of risk sentiment, August has seen the bears dominate with losses mounting for all of the major indices. 

Is the market too hasty on FOMC tapering? 

Looking closely at the FOMC minutes, the market’s reaction seems overdone. Firstly, some members were noted to want to delay tapering until 2022. Importantly, this may have included Fed Governor Jerome Powell who has expressed dovish sentiments in recent months. Added to this, the minutes were clear that tapering did not mean that an interest rate hike was imminent. The minutes also stated that the Fed would only start tapering if the economic conditions continued in their current trajectory and they stated that the US economy has more work to do when it comes to employment. Thus, in our view, the sour mood in financial markets regarding the Federal Reserve’s minutes is overdone. Firstly, these minutes are from the July meeting, since then the outlook has shifted, with retail sales falling more than expected and rising Covid infection rates. At the time of writing, the death rate is more than 1,000 per day, and infections are rising sharply; some hospitals in some states are reporting full ICUs, which could lead to new economic lockdowns. Thus, there has been a notable increase in downside risks to the US economic outlook in the short term. We expect Fed chair Jerome Powell, to communicate this at the Jackson Hole central bankers’ meeting next week. This could calm market nerves and trigger a rebound, however, we still have over a week to wait to hear from Powell and co. and plenty of damage could be done by then. 

FTSE 100: 7,000 at risk in the short term 

The slowdown in China is a major concern for stocks, and this is hitting some sectors harder than others. The ongoing China concerns has caused Burberry to sink to its lowest level since March, the stock fell by more than 5% on Thursday, although we think that further downside could be limited to the January 21’ low at 1,680. While downside could be limited, we still think that the immediate path of least resistance is for more declines, as a cocktail of worries permeates financial markets. Other stocks on the FTSE 100 that have struggled this week include miners, Anglo American fell more than 10% on Thursday as commodity prices including oil, copper and iron ore struggle. In contrast, defensive stocks including Smith and Nephew, Just Eat and National Grid have managed to eke out a gain, however, make no mistake, the market impulse is to sell, and upside volatility is hard to come by right now. 

When will Amazon’s share price stop sliding? 

In the US, once upon a time the market viewed Amazon as a new defensive stock, able to withstand any market conditions, including a global pandemic. How things have changed. Amazon’s share price continues to slide on Thursday and is at its lowest level since June. The slide in the share price since its record high in July is significant from a longer-term perspective, with 3,188 the 23.6% retracement of the Dec 2018 low to the July 2021 high. Amazon is currently trading around 3,200, if it breaches the 3,180 level then we could see a sharper sell off back to 2,840, the 38.2% retracement of the same move. The fundamental drivers of this sell-off are strong, for example the decline in Amazon’s share price started at the end of July due to the company’s first quarterly revenue miss in 3 years and due to weaker guidance. It turned out that the initial sell off back on July 30th wasn’t such a good buying opportunity as the market continues to re-assess what it thinks Amazon is worth. Perhaps Jeff Bezos should have avoided thanking Amazon customers for paying for his pointless voyage into space, could this be Jeff Bezos’ “Ratner” moment? We would argue that Amazon’s economic fundamentals are not all bad, profitability has soared, and if market sentiment livens up later this month then we would expect Amazon’s share price to recover sharply. For now, it is one of the worst performers in the FAANG space, with Facebook and Google the best big tech performers so far this summer. 

The market sell off and FX

Elsewhere, gold is higher, and in the FX space, safe haven currencies are gaining ground quickly. The dollar is stronger across the board and is even eking out a small gain vs. the JPY, another safe haven. GBP/USD is sinking and has fallen below $1.37 as we move to the end of the week. $1.3590 – the 23.6% retracement of the March 20 low to the May 21 high, could stem the downside if the sell-off gathers steam as we wait to find salvation in next week’s Jackson Hole meeting. Elsewhere, there are no pretty things that we can say about the Aussie. AUD/USD is down some 0.88% so far on Thursday and we expect more downside as a confluence of factors should keep the Aussie dollar under pressure for the medium term including: a slowdown in China, a sharp drop in commodity prices including iron ore, which is at its lowest level for 6 months, and a Covid lockdown. These are all bad news for the Aussie dollar in our view. AUD/USD is at its lowest level since Nov 2020, with major support coming in at $0.7080 – the low from end of October 2020, as you can see in the chart below. 

Overall, sentiment is weak and risky assets are selling off.  We think that concerns about the Fed tapering too quickly are overdone, however, liquidity tends to be thin in markets at this time of year and we don’t expect a major pick up in market enthusiasm for risk until next week’s Jackson Hole meeting, although the ferocity of the sell-off could fade as we get to the end of the week. 

Chart 1: AUD/USD