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In early September, bears finally managed to spoil the seemingly endless bull party. The stock market, taking into account a combination of several factors, went into correction. The S&P 500 fell a bit less than 10%, though velocity of decline was hardly frightening with attempts to buy-out almost every drop. Silver and crude also fell (gold weakened in early August already), while the high-yield bonds lost at best a couple of percentage points. European stock markets demonstrated similar indifference.
Thus, the horror stories about the repetition of the March scenario in financial markets continue to look quite exaggerated. Yes, it does look that the market will stay volatile during the coming weeks, and possibly even months, but it does not seem to consider “testing” the March lows.
The recovery of manufacturing activity in eurozone gathered pace in September but was largely driven by Germany. Without its locomotive, output growth in the area would have had weakened to its lowest since June. Germany’s PMI for manufacturing, which accounts for about a fifth of the economy, rose to 56.4 in September far higher than August’s reading of 52.2. Europe’s second largest economy, France, saw its manufacturing sector returning to growth in September – PMI rose to 51.2 in September from 49.8 in August. Britain suffered a record collapse in economic output in the second quarter of 2020 with country’s GDP shrinking by 19.8%. Overall, eurozone’s economic sentiment improved more than expected in September mainly due to a rise in optimism in the services sector. Despite concerns about a second wave of the Covid-19 – sentiment increased to 91.1 points from 87.5 in August. However, area’s inflation fell deeper into negative territory last month, raising pressure on the European Central Bank to add stimulus. Annual inflation in the 19 countries sharing the euro fell to minus 0.3% in September, its lowest in more than four years.
China’s factory activity extended its solid growth in September. Country’s vast industrial sector is steadily returning to the levels seen before the pandemic paralyzed the economy. Activity in Chinese services sector expanded also with official non-manufacturing Purchasing Managers’ Index (PMI) rising.
US labor market showed weakness in September as over 300,000 Americans lost their jobs permanently. The slowing recovery in the sector is the strongest sign yet that the economy has shifted into lower gear heading into the fourth quarter. New orders for the US-made goods increased less than expected in August, though business spending on equipment appeared to be recovering, with factory orders rising by 0.7% after accelerating by 6.5% in July.
Government bonds keep “doing nothing.” Benchmark bond yields are stuck in a very tight range at or near their historic lows. The market seems dormant and waiting for any signs as to which direction to take. It has not happened yet and since we are now only a month away from the US presidential elections, one might be inclined to expect that to be a possible catalyst for the govvies.
As for the credit markets, the best performer was Europe for a change. The Bloomberg Barclays EuroAgg Total Return Index gained 1% in September, as opposed to a slight decline for USD corporate bond index. High yield bond indices were both down in Europe and the US, as risk premiums did inch a bit higher on the backdrop of a “red” month for stock indices.
We were talking about the weakness of US dollar for quite a while and now want to add a few words regarding the longer-term chart of the dollar index (DXY). The greenback has spent its last 5 years in a sideways trading range and is still constrained within these boundaries. Two most likely scenarios, while both seeing the USD higher, are different just in one detail – does dollar need to drop before it goes higher or not? It appears that the safest approach would be to wait for that dip below 89 mark and subsequent move back over 90 points (if any) as a signal to go long in dollar. In case the index cannot recover from 88-89 lows, that would be a warning sign that “something else is playing out”. Should the dollar start to rise to 96-97 index levels without taking out the 89 low, we have “a risk” that the greenback can go higher sooner rather than later.
Gold ended the third quarter hitting all-time highs both in absolute values and on “closing basis”. Technically speaking, it is a valid breakout and now the 2500 $/ounce long-term target can be considered as “activated” with the question being – “how do we intend to reach it?” First (and easiest) scenario is to directly go up from 1900 mark and reach 2500 (where at least part of long positions would be closed and profit taken). Second scenario (and a more realistic one given the current market context) points to a dip closer to 1800 region before we continue to rally. A more aggressive drop to the 1650 region also looks possible and in this case would offer a much better risk/reward opportunity. As always, a shorter-term developments would give us better clues regarding what kind of path market wants to take. One way or the other, the metal offers “inviting” opportunities and it is quite hard not to own it in this massive money-printing environment.
Undoubtedly, what happens next will depend on the market context at every given moment. For example, in the middle of the month, the market looked “rather weak” and the S&P 500 was able to test 3200 levels, but did manage to follow through. Now it looks like it wants to target 3450-3500 region, provided it holds its local lows near 3250 mark. Since this is only the first wave of correction (our base case scenario expects further lows in equities), market rebounds will be frequent and strong. We would like to see the stock market below 3000 points in the S&P 500, but it is very likely that the index will decide to revisit higher levels before falling.