After seven years of unrelenting bull market, we as traders and investors have gotten very accustomed to the market immediately turning higher after a large sell-off.
And by any definition, Friday was a gigantic one. The Dow (NYSEARCA:DIA) tumbled more than 600 points; that's a loss of 3.4% on the session. The Nasdaq (NASDAQ:QQQ) and S&P 500 (NYSEARCA:SPY) declined by even greater amounts on a percentage basis.
The S&P 500, which seemingly spent all of spring fighting in a 50-point range between 2,050 and 2,100, tumbled out of it in one go. Futures hit as low as 2,000 Thursday night, and the market - while it did recover somewhat - closed down at 2,037, off a shocking 76 points on the day.
This was a meaty sell-off indeed; not just garden-variety profit-taking. And for people hoping for a "V" bounce and move back to 2,100, developments since Friday's close have not been promising.
The Briefing highlighted several factors to watch Friday to see if this sell-off would quickly reverse or would continue and deepen. So far various of these indicators are pointing to more trouble. The banks are still sliding today, the Pound (NYSEARCA:FXB) continues its historic tumble, and Chinese currency stress is building.
Currency Moves Worsen
The British Pound fell from 1.50 prior to the Brexit vote to 1.35 on Friday. In the hectic overnight session, it fell to as low as the mid-1.32s.
As of this writing early Monday morning, the Pound has just taken out the overnight lows and is threatening to break below 1.32. This is not conducive to a quick recovery in global equity markets. Rather than finding bottom and starting to stabilize, the Pound continues its erosion.
The other strong currency moves from Friday also have extended themselves. The Euro (NYSEARCA:FXE) continues to slide and at this hour has its sights on taking out 1.10. Meanwhile in Japan, the currency that no one wants to strengthen, the Yen (NYSEARCA:FXY), continues to soar ever higher. A retest of the key 100 level looms.
As for the US Dollar (NYSEARCA:UUP), it is up another percent this morning, and it has now reclaimed the midpoint of its 52-week range. The talk of an imminent dollar breakdown was loud across the analyst class earlier this month. You can put that to rest, the Dollar has found strong support and isn't going to break 90 anytime soon. In fact, another run up to 100 seems quite plausible later this year.
China: Mounting Tensions
Like in 1998, when Russia defaulted, the worst part of Brexit may well not be the vote but the aftershocks it caused. Russia's default in 1998 was a foreseeable event, and honestly shouldn't have caused the sort of mayhem that it did.
But due to the wonders of overleveraged hedge funds and bank risk managers asleep at the wheel, it turned into a full-on contagion that caused a more than 10% drop in US equities and required a government-organized banking backstop to prop up the financial system. (Bear Stearns, the bank that held out on taking part in the backstop in 1998, was rumored to have been allowed to fail in 2008 as a settling of this grievance).
Today, Brexit is unlikely to be a big deal beyond the short term. Britain's economic position is improving actually, with a weakening Pound their exports and tourism position improves. And the concerns about separation from the EU seem overblown to this author's eyes.
However, the real problem is that the world got caught totally off-guard, and a lot of people had leveraged positions in the wrong direction. Now the unwinding of bad trades, aided by margin calls, is causing chaotic trading particularly in bonds and FX. These markets may not get the press that equities do, but lots of "serious" investors have tons of highly-levered bets in these areas. Make no mistake, if these currency dislocations continue, you'll see banks and hedge funds taking massive losses and shutting down.
On that note, watching currencies is a good tell to see where the next problem will arise if Brexit sets off a rolling panic. And early signs point to China. The Chinese Yuan had its biggest one-day devaluation since this past August last night. Let's not forget how dramatic an equity sell-off that August devaluation caused.
With the move lower last night, China's Yuan now sits at 5-year lows against the US Dollar. Economic signs have pointed to steady weakening in recent months within China. The acceleration of that from managed slowdown to uncontrolled fall would be a dramatic accelerant for the current global unease.
Stocks Falling Again
Stock futures opened moderately lower last night, but reversed during the evening and even moved into the green for a bit. Once Europe opened, however, these gains quickly gave way. Perhaps more political unease from the Spanish election results on Sunday, or who knows what.
In any case, the European banks tried to put on a brave face at the open, but serious selling has resumed. At this hour, Royal Bank of Scotland (NYSE:RBS) is down 17% in British trading, and Lloyds (NYSE:LYG) is down almost 10%.
In the US, S&P 500 futures have slumped again, revisiting the 2,000 level and down 1% over the past couple hours.
One interesting thing to watch today will be if the UK (NYSEARCA:EWU) and the rest of Europe recouple. British stocks actually only closed down by a few percent on Friday in London trading, while the rest of the continent got drubbed. Losses for many of the indices were around 10%.
In Spain, the Ibex suffered its worst one-day loss ever, down 12.4%. The iShares MSCI Spain Capped ETF (NYSEARCA:EWP) was down 16% on the day accounting for the currency impact. Other weak periphery nations faced similar losses; Greece (NYSEARCA:GREK) was also down 16% on the day in dollar terms. Even France (NYSEARCA:EWQ) got hit for a more than 11% decline.
It's an interesting divergence, and perhaps speaks to the purported benefits of currency devaluation. In any case, the general trajectory for almost everything equity related continues to be lower as Monday dawns around the world.
For today, it seems likely that the US markets will break the Thursday overnight low, with the S&P 500 making a big additional push lower. After that, a rapid rebound would certainly make sense. But don't expect this market to repair itself all that quickly. Friday did some serious damage, and what we've seen since then is that the aftershocks are still causing more concern.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.