Buy Signals May Actually Be Sell Signals in Equity Markets

Your Real Vision Daily Briefing for August 10, 2020

Ed and Ash analyze bank balance sheets in Europe, supply constraints of consumer staples, volatility, market breadth, and “bear steepening”.

  • We’re reaching a potential inflection point in the market where buy signals may actually be sell signals.
  • We could see a volatility spike in September driven by market internals as opposed to fundamentals.
  • The compression of net interest margins is damaging bank earnings in Europe.

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Ed Harrison discussed an emerging theory he’s mulling following recent interviews with Milton Berg and Charlie McElligott during today’s Real Vision Daily Briefing.

Harrison said the interviewees posited that we may be reaching a potential inflection point in the market. We saw the rally after the March 23 low, then around June 8-11, when the Fed’s balance sheet was the biggest, there were a handful of buy signals. Harrison said these signals came at a weird time and the price action since has been strange.

Since June 8, which was the peak for a lot of markets, we are getting bullish signs like the S&P 5-day breadth, which was 3.0 to 1 for the first time since 2014. However, Harrison said that after the interviews, he thinks maybe what you’d think would be buy signals may actually be sell signals because there is commodity-like momentum building up in the equity markets.

While September through December is typically a pro-cyclical risk-on period, Harrison said there could be an inflection point in September in particular from crowded trades.

“All of these plays are actually bond proxies,” he said, “and if it is a bond proxy, all of those trades will sell off, except maybe gold and silver.”

Harrison also discussed increased volatility in the markets. February and March were off-the-charts high volatility months, but those months have fallen off the VAR model, he said. For investors doing any sort of volatility-based VAR type of leveraging, that means any trading they do will see them leverage up as volatility goes down.

“The result is right now as this inflection point is going to hit, people are leveraging up into the momentum trades and that will cause a massive reversal to the degree that volatility spikes in September,” he said. “It’s all market internals as opposed to fundamentals that would drive that action.”

Harrison ended the conversation with a brief look at European banks banks and discussed how their narrower profit margins relative to U.S. banks make them less able to weather the storm in times of economic crisis.

Harrison pointed out that Europe is more dependent on bank lending because of less developed capital markets, and that matters because an impact on European banking would have larger impact on total credit available in the economy.

Europe will have more credit write downs on their balance sheets relative to their GDP if bad things happen, as opposed to the U.S. where risk is absorbed into the markets, Harrison said. It’s one way in which Europe is more exposed than the U.S. during this crisis.