Stocks Halt Rebound as Oil Hits $80 on War Angst: Markets Wrap

This content was published on August 12, 2024 - 22:53

9 minutes

(Bloomberg) — Stocks struggled for direction ahead of US inflation data, with the latest geopolitical developments curbing the appetite for risk.

Just a week after the panic selling that shook trading around the globe, the S&P 500 was flat. With Wall Street still reeling from last Monday’s wild gyrations, many investors are refraining from making big bets as they await more signals about the health of the world’s largest economy. Oil hit $80 and bonds gained as the US believes an Iranian attack against Israel is increasingly likely.

To Solita Marcelli at UBS Global Wealth Management, it’s a good time for investors to “take stock” of how far key markets have moved.

“Volatility could return this week,” she said. “If inflation is too low, this may heighten concerns that the US may be heading for a recession. If inflation is too high, it could encourage fears that the Federal Reserve may be unable to cut rates quickly enough to protect the economy. Geopolitical risks also remain elevated.”

The S&P 500 hovered around 5,345. Most major groups fell, though tech, energy and utilities gained. The Russell 2000 of small caps extended its August slide to 8.5%. The Cboe Volatility Index — the VIX — edged mildly higher — after an unprecedented spike last week.

Cboe Global Markets Inc. acknowledged that thin trading premarket played a role in the VIX’s violent move last Monday — but said its surge was justified by the mounting angst over the contagion risk emanating from a crash in Japanese currency and stocks, which led to the yen carry-trade unwinding.

“When the world feels uneasy, people feel less inclined to take risks,” said Callie Cox at Ritholtz Wealth Management. “But fear can be a healthy dynamic for a market that thrives on clearing low hurdles. When it turns out that bad news isn’t as bad as people think, they pile back in.”

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To Keith Lerner at Truist Advisory Services, following past volatility shocks, we tend to see wide swings in both directions, and the repair process typically takes time.

“Indeed, after such a sharp move down, there tends to be a battle between fear and greed,” Lerner said. “There is fear of more downside, which causes some investors to continue to sell on any bounce, and then greed on the other side, where those investors who were waiting for a pullback wade in.”

Notably, to gain further confidence, investors will be waiting for some of the higher profile reports/events like Fed Chair Jerome Powell’s speech in Jackson Hole and Nvidia Corp.’s results this month. In the interim, each economic report will likely be overly scrutinized, he said.

US inflation probably picked up modestly in July, but not enough to derail the Federal Reserve from a widely anticipated interest-rate cut next month.

“Investors will be looking for the numbers to land in a sweet spot,” said Chris Larkin at E*Trade from Morgan Stanley.

After last week’s turmoil, markets will be focused on Wednesday’s consumer price index to see if the Fed will have a freer or more constrained hand in refocusing on the labor market and front-loading rate cuts sufficiently to secure a “soft landing,” according to Krishna Guha at Evercore.

“But do not panic if CPI is on the hotter side,” Guha noted. “This is now a labor-data first Fed, not an inflation-data first Fed, that is less data-point dependent, more forward-looking. We think if coming labor data stays soft, the Fed will still be forward-leaning on cuts.”

During the most-recent turmoil, investors slashed equity allocations at the sharpest pace since the onset of the pandemic, according to Deutsche Bank AG. An analysis of previous growth scares suggests that stock correlations and volatility will “will only gradually recede back to ‘normal,’” said Goldman Sachs Group Inc.’s David Kostin.

If economic worries abate, “then the recent selloff represents an opportunity to buy stocks with healthy fundamentals at valuation discounts,” he wrote.

Morgan Stanley’s Michael Wilson says a double whammy of economic uncertainty and a weak period for corporate earnings forecasts is likely to cap stock market gains.

The strategist — among the most notable bearish voices on US equities until last year — said he expects the S&P 500 to trade in a range of 5,000 to 5,400 points as macroeconomic data flash no clear signals over the short term.

The risk-reward for stock markets remains mixed over the summer months against the backdrop of weakening business activity and negative earnings revisions, according to JPMorgan Chase & Co. strategists led by Mislav Matejka.

“Fed will start cutting, but this might not drive a sustained leg higher, as the cuts might be seen as reactive, and behind the curve,” they wrote.

Investors will have a brief window to buy the dip in US stocks at the end of this month as selling pressure from systematic funds eases while companies boost share buybacks, according to Scott Rubner at Goldman Sachs Group Inc.

More near-term dips can’t be excluded if activity data surprise negatively, but investors should buy stocks on weakness as fundamentals are still supportive of risk assets, HSBC strategists say.

The team led by Max Kettner sees signs of stabilization after a significant volatility shock, with focus returning to fundamentals as the dust settles.

At least one indicator suggests that last Monday’s drama looks more like a minor meltdown than a harbinger of worse things to come.

Consider the Cboe Volatility Index and the option-adjusted spread on the Bloomberg US Corporate Bond Index. Based on a long-term relationship between the two, the VIX’s close near 39 a week ago was supposed to correspond to a reading of 3.5% in corporate bond spreads. Yet they ended much lower, near 1.32%.

The mismatch between the two suggests the recent downdraft was technical and not indicative of economic doom, according to Bloomberg Intelligence strategists Christopher Cain and Michael Casper. In fact, such abnormal disconnects in the past have led to above-average returns for stocks over the next three-to-six months.

Tom Essaye at The Sevens Report says he doesn’t think fundamentals have deteriorated enough to warrant de-risking and reducing equity or risk exposure — but he also wants to caution against dismissing the recent uptick in volatility.

“Much of what I read over the weekend characterized this recent volatility as just a typical pullback in an upward-trending market,” Essaye. “Because of that, I continue to advocate for defensive sector exposure and and minimum volatility funds.”

Corporate Highlights:

Bank of Nova Scotia is making good on plans to invest more capital in the US with a $2.8 billion deal for a minority stake in KeyCorp, which was among the US regional banks hit hardest in last year’s tumult.
Johnson & Johnson has cleared a key hurdle for advancing a $6.5 billion plan to resolve thousands of lawsuits by people who say its baby powder gave them cancer, according to people familiar with the matter.
B. Riley Financial Inc. tumbled amid a new round of writedowns and a widening US investigation into whether it gave investors an accurate picture of its financial health.
JetBlue Airways Corp. has kicked off a $2.75 billion bond-and-loan sale backed by its loyalty program as the carrier seeks to raise reserves and fund general corporate purposes.
Eli Lilly & Co. sold $5 billion of bonds on Monday to help fund its $3.2 billion acquisition of gut-drug maker Morphic Holding Inc., after recession fears triggered a turbulent week.
Vestas Wind Systems A/S issued a profit warning for its full-year results in a blow to the company’s effort to turn around steep losses in recent years.

Key events this week: