Yet another turnaround Tuesday

Markets

After a day of financial market chaos, investors are dipping their toes back into the US market's choppy waters as a tentative calm returns to global markets following a period of absolute terror. Taking cues from a rebound in Tokyo, the epicentre of the recent mayhem, the US market opened higher on Tuesday. Momentum and dip buyers sifted through the Summer Storm's aftermath, finding cheaper bargains scattered among the debris.

By the close of trading in New York today, all major groups in the S&P 500 were riding high, with the index finishing 1% up. The fact that the market not only stabilized but also moved higher should take the steam out of the bond market's attempt at forcing an inter-meeting "Panic At The Disco" Fed rate cut.

So there you have it, yet another “Turnaround Tuesday”. It's funny how that trade works far more often than not.

'Turnaround Tuesday' truly lived up to its name with the dramatic surge in Japanese stocks. After a jaw-dropping 12% plunge—their second-largest drop on record—they astonishingly rallied 10%, marking their third-largest rise ever. It was a real financial rollercoaster!

Yet, these wild day-to-day fluctuations, often driven by nothing more than the capricious whims of speculative traders, serve as stark cautionary flags. This volatility is typical of more prolonged and chaotic market downturns, which could prompt investors to adopt a cautious stance, hold on tight, and keep the antacids ready.

Indeed, don’t get too comfy—our old friends, the Recession Demon and the VIX Drama Queen, aren’t going to let you off that easily. Market bears are still on the prowl, reading the tempest in their tea leaves. They might keep selling the rally tape, thinking that volatility is here to stay until the Fed decides in September. So, brace yourself for some rapid swings in both directions—the market could soon resemble a teeter-totter on a caffeine high.

To put it another way, the burning question now is whether the fears that sparked the market's selling frenzy have truly been extinguished. Are we merely basking in a fleeting calm, or is there real stability on the horizon?

Volatility spike sellers often emphasize that ridding the market of long and wrong trades takes time. When volatility spikes, the VIX tends to settle into a higher trading range, and it usually takes around 30 to 40 days to flush out the bad noise. However, given the recent silliness, any remaining longs above 50 should quickly realize they've got eggs on their faces. Still, with a couple of potential “volpocalypse” scenarios on the horizon—like the Jackson Hole Symposium from August 22-24, the Fed meeting on September 17-18, and the run-up to the November US election, which some argue was a component of the Summer Volatily Storm—we could be in a volatile regime for some time. This could keep systematic buyers, who typically dive in when the VIX is below 20, anchored to the sidelines.

Regarding the “ Panic At The Disco “ trade, sure, hedging was the game's name when sheer pandemonium struck on Monday, and the market was waving "Black Monday" flags like a NASCAR pile-up. But with the Morning After reevaluation, as misery turned to a punchline, it was clear that holding onto that inter-meeting rate cut trade was about as good an idea as entering a feral cat herding contest.

Echoing this sentiment, industry insiders like Goldman Sachs Chief Executive Officer David Solomon advise everyone to cool their jets.

Forex markets

In our latest FX trading strategy, affectionately termed the "Wounded Duck," we're cautiously positioning to sell the US dollar. This move is predicated on the expectation of a substantial 50 basis point rate cut by the Fed in September. Such a cut would narrow the rate differential with the EURO, destabilizing the USD carry trade, and should favour currency risk betas that flourish in sprightly risk markets. This anticipated action would diminish the dollar's stature as a safe haven, relegating it to wallflower status at the currency sanctuary dance while partners like the Japanese yen and Swiss franc take the floor.

However, if the Fed decides on a more conservative 25 basis point cut, it could unexpectedly boost the dollar's appeal, showcasing that sometimes, less can indeed be more in the delicate dance of currency markets.

Of course, there remains a clear and present danger to the short-dollar strategy if next week’s US CPI unexpectedly throws a curveball.

The Asian FX market is recalibrating, focusing on a less bullish but surprisingly resilient USDCNH. This week, despite pervasive risk-off sentiment driven by fears of a U.S. recession negatively impacting local equities, the Asian FX complex still managed a rally—an atypical response under such conditions. This adjustment may signal a subtle realignment in response to overarching global economic indicators. Notably, similar to the unexpected surge in the Japanese Yen, the yuan's rally appears to have been fueled by a carry trade unwind involving the Indian Rupee, which faced significant challenges yesterday. This suggests a broader pattern of reactive and nuanced shifts across key currencies in the region.

Oil markets

As risk markets found their footing on Monday, crude oil prices bounced back from the previous day's selloff, fueled by a resurgence in risk appetite across the financial landscape.

The technical traders were back in action, eyeing the recent downward movements in oil prices as a key buying signal. They noticed that oil was significantly oversold, as indicated by a sharply dipping Relative Strength Index (RSI). This suggested to many that oil was "well overcooked" on the downside, sparking a flurry of activity to capitalize on potential corrections.

The physical market showed signs of tightening, adding momentum to the rally. Libya’s largest oil field, El Sharara, saw a significant reduction in production after operators were instructed to scale back. Output at the field plummeted to about 210,000 barrels per day—a drop of at least 50,000 barrels.

Moreover, the shadow of rising geopolitical risks is causing traders' nerves to fray. The potential for retaliatory attacks by Iran or regional militias on Israel is adding fuel to the fire. Any spike in Middle Eastern tensions could drastically heighten the risk of supply disruptions, effectively leaving oil traders feeling as though they’re perched precariously on a barrel of dynamite.

With the oil market in flux and geopolitical tensions on a slow boil, traders are buckling up for what's shaping up to be a rollercoaster ride.

Turnaround Tuesday

Trading in fast markets often reveals some predictable patterns, one of the most consistent being “Turnaround Tuesday.” This phenomenon typically sees stocks surge on Tuesday if they've experienced declines on the preceding Friday and Monday. The rationale behind this pattern is fairly straightforward and rooted in human behaviour.

When unsettling news hits late in the week, traders jittery about heading into the weekend with too much risk might trim their holdings on Friday. Over the weekend, a barrage of negative media coverage about whatever the looming issue may be amplifies these fears, e.g., “ Black Monday In Tokyo,” prompting further sell-offs on Monday.

This wave of investor selling attracts momentum traders who decide to go short on Monday, exacerbating the downward pressure. By the time Tuesday rolls around, the pool of sellers has dried up. With no one left to continue pushing the market lower, those short positions start to feel the squeeze. This, in turn, often triggers a rebound, or what's fondly referred to as Turnaround Tuesday, as the market corrects somewhat from the reactionary sell-off.