Friday’s close on stocks, commodities and forex markets could have been worse.
But if markets hadn’t got ahead of themselves things might not have been as fractured on Friday either. So with the dust barely settled the outlook as we start the new week is for more pressure. But more likely than not the acute phase of volatility is behind us.
At the close Friday the S&P 500 was down 76 points for a 3.6% loss, the FTSE in London was down just 3.15% even though its banks were hammered, but the falls in Frankfurt and Paris were heavier with the indexes down 6.82% and 8.04% respectively.
The washup was the SPI 200 futures are up 3 points. The question for local traders though is can they resist the pressure that is likely to continue to weigh on stocks?
On forex markets the Aussie dollar is at 0.7415, down 0.6% on Friday’s close and perhaps an indication of that potential weight on stocks today. USDJPY is at 101.76 and the pound is down at 1.3419. It’s off almost 2% in early trade, no doubt as a result of the already growing political uncertainty in the UK surrounding a potential Scottish veto, change in conservative leadership, and Labor leader Jeremy Corbyn under pressure.
Gold remains strong at $1315 and along with bonds – Aussie 10-years closed at 1.985% on Friday – looks the most likely candidate to benefit from the ongoing uncertainty.
Here’s the scoreboard (7.41am):
- Dow: 17400 -610 (-3.39%)
- S&P 500: 2037 -76 (-3.59%)
- SPI200 Futures (September): 5,074, +3 (+0.1%)
- AUDUSD: 0.7415 -0.0207 (2.72%)
Now, the Top Stories
1. Brexit is not Lehman Brothers, yet. Sterling had its worst day in history, biggest range ever, and traded at 30-year lows on Friday. So it might seem a little strange that I say that Brexit is not Lehman. But the reality is it is not.
The reason for that is even though Lloyds Bank shares fell 21% and RBS shares dropped 27% in trade Friday, Brexit is different to Lehman Brothers because the collapse of Lehman, and its US-based pre-cursor, the collapse of hedge fund LTCM in the 1990s, brought about big losses to financial institutions and had banks questioning each others’ solvency. That in turn saw the wheels of global finance seize up as institutions, investors, and traders questioned the survival of banks as big as US behemoth Citigroup. In the end, it was only Gordon Brown in the UK backstopping his system and TARP backstopping US finance which stopped the panic.
Brexit is an economic event in its consequences, lower growth, lower rates, lower inflation, and a lower exchange rate. It is, as Goldman Sachs says (see item 2 below), right on central bank home turf. It’s only if we find some bank somewhere has flouted all of the work done by central banks and banking regulators in the wake of the GFC and blown itself up that global finance will seize up. But as traders found out Friday, Sean Connery was right – you should never say never.
2. Here’s a list of 25 Australian stocks that could be hit by Brexit. On Friday the big losers on the ASX were stocks which were readily identifiable as having big UK operations. CYBG, which is the holding company for former NAB subsidiary Clydesdale Bank, fell 17.51%, fund managers BT Investment Management dropped 14.19%, Henderson Group lost 12.03% while IRESS and Westfield also came under pressure.
But Credit Suisse says that there are many more Australian companies which could potentially be caught up in the Brexit maelstrom. Paul Colgan reports the CS research team led by Hasan Tevfik said “while many UK-exposed companies have already endured a considerable sell-off, for now we think most of these companies are only for the brave”.
3. What is the RBA thinking now? Contingency planning is one of the key things that central banks and global regulators have pushed on the banking system in the aftermath of the GFC. So it would very strange if the RBA, and their global central banking counterparts, hadn’t ran a Brexit scenario through their models to stress test the economy at both a local and international level.
But while there are companies at risk via direct linkages to the UK, the reality is that the Australian economy is pointed more to our north than north-west toward the UK or Europe. China matters, as does our self-generated growth through our enormous domestic services and consumption base. That means the RBA is likely to be alert but not alarmed.
Looking further out, the NAB says that if “the global growth outlook slows in coming months the RBA would revise down its growth forecasts and the probability of further rate cuts would increase”. Indeed depending on how bad the market’s reaction is – stocks and credit spreads in particular – over the week and a half ahead, the NAB says “the Bank might consider a stabilising rate cut as early as July, as it did during the Global Financial Crisis”. But “this seems unlikely”, the NAB says.
4. Goldman says central banks have got this. As you can see above I’m betting that we are on central bank home turf with the fallout from Brexit. That’s a view that Andrew Benito, senior European economist at Goldman Sachs seems to hold as well. In a note Friday Benito said he expected “the BoE to stand behind markets and to maintain market functioning” and that BoE governor Carney’s announcements (not to mention those from the BoJ and ECB) “are intended to mitigate foreign exchange volatility and support bank funding, including foreign currency funding”.
He also believes the BoE will backstop bank funding costs -– a crucial circuit breaker to avoid a LTCM or Lehman rerun. Benito said “should bank funding costs rise, as seems quite likely, we would also expect the BoE and HM Treasury to announce an extension of the Funding for Lending Scheme”.
5. But that DOES NOT mean the worst is necessarily over for markets. There is little doubt Friday’s trade could have been worse. That means many of the uber-bearish targets that banks were warning about in the run up to the EU referendum have yet to be fulfilled. And so there is still a psychological overhang in economists’, strategists’, traders’ and investors’ minds about the impact of the decision to leave the EU.
Paul Colgan reports that Andrew Sheets, Morgan Stanley’s chief cross-asset strategist (and therefore a man in a helicopter with vision across many markets) said that “financial markets discount years of expected impact in an instant”. That’s what happened Friday but he added that “this discounting process may not be finished. Our FX strategists believe that GBP will ultimately fall to 1.25-1.30. Our equity strategists believe that European and UK stocks may need to correct a further 7-10% over the next several months.”
Many believe this, meaning it could become self-fulfilling. The key is whether or not that forecast is right, we know that given the uncertainty at least for a period of time, traders will act as though that’s where markets are headed.
And that, as Colgo suggests, means Brexit market carnage may not be over.
6. More uncertainty – George Soros says the breakup of the EU is “practically irreversible”. If you are wondering why markets might remain on tenterhooks now that the result of the Brexit vote is known look no further than legendary hedge fund manager George Soros for an explanation. Soros says that even though Britain had the best deal in Europe, it still voted to leave the EU and as a result “the catastrophic scenario that many feared has materialized, making the disintegration of the EU practically irreversible”. He says the British economy faces consequences “comparable only to the financial crisis of 2007-2008”.
That in itself is enough to trouble traders given the UK is the world’s 5th biggest economy. But Soros is worried that “Brexit will open the floodgates for other anti-European forces within the Union. Indeed, no sooner was the referendum’s outcome announced than France’s National Front issued a call for ‘Frexit’, while Dutch populist Geert Wilders promoted ‘Nexit'”. He adds that “tensions among member states have reached a breaking point, not only over refugees, but also as a result of exceptional strains between creditor and debtor countries within the eurozone”.
Uncertainty is poison for traders and markets.
Oh, and here is my diary of all the key data and events in the week ahead.
Key data for the past 24 hours (with thanks to BNZ markets)
UK: Referendum: “Leave”
GE: IFO business expectations, Jun: 103.1 vs. 101.2 exp.
US: Durable goods orders (m/m%), May: -2.2 vs. -0.5 exp.
US: Uni. Of Mich. cons. sent., Jun F: 93.5 vs. 94.1 exp.
You can catch me on Twitter.
And now from CMC Markets’ Ric Spooner is today’s Stock of the Day
NAB’s UK spinoff Clydesdale and Yorkshire is symptomatic of the Brexit effect.
A month ago, the bank’s share price rallied 24% after it delivered a pleasant surprise with the extent of forecast cost savings. On Friday, the CYB’s ADR listed on the ASX plummeted 17.5%.
A big part of this was the impact of the crash in the value of the Pound against the $A and its effect on the $A value of the ASX listing. The rest was down to risk premium being built in for the macro impact of Brexit.
In the final wash up; CYB shares fell 13% in London on Friday to £2.50. That means Friday’s $A closing price of $4.57 looks pretty close to the money, depending on how GBPAUD moves this morning.
Once market volatility gets high, it tends to stay that way for a while. Even if this stock does steady today, it’s hard to be confident we’ve seen the bottom at this stage. Potential support levels below here look to be $4.40; $4.20 and $4.00
Ric Spooner, chief market analyst, CMC Markets
You can follow Ric on Twitter @ricspooner_CMC