“Perfect Storm” Puts This Year’s European Gains At Risk

By Michael Msika, Bloomberg Markets Live reporter and strategist

August was expected to be a risky month, and so far it has delivered. Now technicals are starting to look shaky and investors are bulking up their hedges as the rest of the month still promises plenty of risk events.

After an almost relentless drop since the start of the month, the Stoxx 600 is nearing technical oversold territory, though it remains in the range that’s been in place since April. For the euro-area benchmark Euro Stoxx 50, things are looking trickier after the index exited its uptrend in place since the start of the year, while testing a major support around 4200 and its 200-day moving average.

“Markets are being hit by the perfect storm, amid surging rates, worsening economic data in China, poor summer liquidity and a buyers’ strike,” says Barclays strategist Emmanuel Cau. “Soft-landing complacency is gone, not uncertainty.”

Equities were pricing in a rosy outlook at the start of the month, with peak rates in sight and a resilient US economy pointing to a soft landing. But the recent surge in bond yields, combined with still-hawkish rhetoric from central bankers and a deteriorating outlook in China, are challenging the view.

Investors were forced to chase the rally earlier this year; now they are bulking up their hedges. The put/call ratio spiked to highest since March last week, while volatility has jumped to the most elevated level since May in the US and in Europe.

“Though supports have not yet been broken on most indexes, we have to underline that VIX is now in a bullish trend,” says DayByDay technical analyst Valerie Gastaldy. “It is a warning sign that indexes are fragile.”

Money managers are unlikely to keep cool in the coming summer weeks, as more risk events may further upset the mood. The Jackson Hole Symposium on August 24-26 could offer some clues on the Federal Reserve’s policy path and the economic outlook. In the meantime, investors are seeking refuge in cash. Year-to-date inflows to money-market funds have already exceeded the record of 2020, reaching $925 billion, according to BofA, citing EPFR Global data.

“We maintain our view that European equities will fall by up to 10% through the summer,” say Morgan Stanley strategists led by Graham Secker. “Proverbial soft-landing hopes are likely to be challenged short-term by EU and China weakness, medium-term by the lagged impact of higher rates and tighter credit.”

To be sure, this might just be an episode of summer volatility and some, like Julius Baer strategist Mathieu Racheter, recommend buying the dip as they see limited contagion risk from China. He still favors stocks with quality growth characteristics, as well as defensives.

“We think it’s a buying opportunity,” Racheter says, “We continue to believe that the secular bull market is still alive and that markets will move higher into year-end after the seasonally weak period of August to October.”