European markets, index futures and benchmark government bond yields all declined further this morning, leading to a sharply lower open on Wall Street today. Safe-haven yen, franc and gold all rose initially in response, before giving back their gains. With these markets not displaying full-on bearish characteristics, it makes us wonder whether equity indices have fallen too far, too fast.
May has been a bad month
Risk has been generally off the menu since the start of May and there’s little sign of the bulls coming back in just yet now that we are heading towards month-end. Undoubtedly, it is all to do with the global economic slowdown fears and more so with the escalation of trade tensions between the US and China. Investors, who bought the optimism during the first quarter, have been left frustrated. After building it up so much, leaders of the world’s largest economies failed to reach a trade agreement last month. Since then, both sides have raised tariffs on each other and warned about more protectionist measures. It has been reported in the Chinese media that Beijing is ready to use rare earths export ban to strike back in the trade war. Should China go down that route, things will surely turn very ugly indeed. We doubt that would be the case, however. Both sides still want to secure a deal at some point down the line, but right now they appear very far from achieving that.
Can stocks stage (surprise) rebound?
But unless the situation deteriorates further, we could see risk assets stage a short-term recovery from these oversold levels in that not-too-distant future. For that reason, we are a little sceptical about this latest technical breakdown in the major indices such as the S&P 500, below. However, for sentiment to turn decidedly bullish, the markets will need to see encouraging signs from both camps that they are ready to sit down and work on a deal.
At the time of writing, the S&P 500 was testing potential support at 2778 after gapping lower at the open. If the index fails to find any bids soon then the next support at 2750 would be the next logical objective for the bears. However, in the event of the resurrection of the bulls, we would only turn bullish on the S&P if it goes on beyond a short-term bounce to break a recent high, with the most recent high in this case coming in at 2840. The least the bulls would be hoping to see is the filling of the overnight gaps the cash indices have left behind from yesterday’s close. The S&P 500 officially closed at 2802.39 yesterday and so this might be the very near-term bullish objective should we see a bounce now.
Figure 1:
