Stock volatility is rising and this week poses ‘huge event risk’ — here’s what to watch for
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Just when markets were drifting into the end of the year, a dose of volatility returned to global equities last week.
One catalyst was commentary from US Fed chair Jerome Powell, who suggested a couple of things;
1. inflation shouldn’t be referred to as ‘transitory’ any more, because it’s proving more stubborn; and
2. the Fed may accelerate the tapering of its bond-purchase program.
Rate rises aren’t on the cards yet, but the mere hint that central bank liquidity may tighten faster than expected appeared to be enough for some serious wobbles in post-COVID boom sectors.
These are now “turbulent markets”, says Chris Weston, Head of Research at trading platform Pepperstone.
In addition, the week ahead poses “huge event risk” — centred around US inflation data for November which is due on Friday night.
Australia’s RBA will also be on deck with its monthly policy announcement tomorrow (CBA expects no major changes to the bank’s current forecasts).
Local stocks have opened the week flat this morning, following a sharp selloff in the tech-focused Nasdaq on Friday night.
Here’s what Weston says is happening — and what investors should be looking for next.
Now the outlook for central bank liquidity looks a lot more uncertain, the “liquidity beneficiaries have been savaged”, Weston says.
Crypto is one asset he puts in that camp, as well as the much-discussed high growth tech names.
In Australia, arguably one of the closest manifestations of a ‘liquidity beneficiary’ is the BNPL sector, which has come under serious pressure in recent weeks and tanked again in morning trade today.
Globally, Weston noted that most of attention is on ARK Innovation ETF — the fund run by high-growth tech enthusiast Cathie Wood which has slumped by more than 25% over the past 20 trading days.
(Ed note: readers may recall this fun battle that played out just a few short months ago — Michael Burry vs ARK Invest — who will emerge victorious?)
Lots of investors are shorting the ARK ETF “and they’d be eyeing Tesla given its 9.15% weight on the ARK fund,” Weston said.
In fact, one enterprising fund has created an ETF dedicated solely to taking the opposite side of Wood’s trades with an ETF called SARK (as in ‘Short Ark’).
Tesla shares slumped 6.42% on Friday night to close at US$1,1014, and Weston said a break of the US$981–US$1,000 range could send ARK really tumbling.
“One for the radar”, he said.
A confluence of post-COVID factors (liquidity taps on blast, supply shortages) have combined to allow the inflation genie to climb out of the bottle after after a decade-plus of next to no growth.
On that front, Friday night’s US inflation print will be another marquee event on global markets this week.
The consensus forecast is for an annual gain of 6.7%, and Weston noted that seven of the last night inflation prints have beaten expectations.
In that context, investors need to ask themselves what kind of inflation number will be required to really move the needle on another round of market-moving repositioning trades.
The fallout from a higher print would probably start in the bond market, before flowing through to strength in the USD which in turn would impact “second derivatives such as the Nasdaq100 and gold”, Weston said.
“For me, inflation with a 7 as the big number would get the USD higher,” he said.
While central bank policy makers may have a challenge on their hands to unwind historic levels of stimulus without tanking equity markets, the prospect of tighter liquidity at least raises the prospect of more volatility in the months ahead.
With that in mind, Weston provided some brief insights into how investor flows and positioning can reinforce existing moves.
For example, the standard date for options trades to expire is the third Friday of every month (Friday December 17th).
Right now, “open interest is clearly skewed for downside structures”, Weston said.
The US S&P500 closed on Friday at 4,538. If it falls through 4,500 then “dealers and options market-makers will have to hedge their exposure, and that means shorting the S&P500”, Weston said.
That also means that once markets open for trade on the following Monday, dealers might be left with “a ton of short inventory, potentially resulting in a solid swing as dealers buy back positions”.
So as uncertainty and volatility increases, it pays to be aware of how trading flows can exacerbate trends — either up or down.
“This means staying vigilant and alert to the risks and nailing the risk exposure and position sizing,” Weston said.