Stocks slide as markets look to Brexit deadline, more Covid restrictions

Morning Note

“I love deadlines. I like the whooshing sound they make as they fly by.”

Douglas Adams, meet Brexit talks. Time is relative, so are deadlines.

The Oct 15th deadline was a bargaining chip – talks are expected to continue for now despite ramping of no-deal preparations.

The EU summit kicks off today with European leaders set to discuss progress on trade talks.

So far there are no signs of a compromise leading to a breakthrough, though fears the UK would walk away from the talks today seem to have eased with negotiators adamant they can get a declaration in the next couple of weeks.

I think we could easily see another month of toing and froing over the final sticking points around the level playing field, governance, and fisheries.

Bottom line, both sides want a deal and as far as sterling is concerned, it’s still a currency people want to own. Sensitivity around headlines is marked which makes it difficult to call where the price action is headed – for now, GBPUSD is within its range of the last month and a half.

There is a strong risk-off tone to today’s trade in Europe. Fading stimulus hopes, Brexit risks, and rising virus cases across Europe – all make for a nasty cocktail for risk appetite this morning after stocks fell in Wall Street yesterday.

Treasury Secretary Steve Mnuchin said it would be difficult to get a deal done on stimulus before the election as the Republicans and Democrats remain far apart on certain issues.

France has locked down its cities, Germany has posted a record increase in daily cases. The UK is heading for further restrictions that will hurt the economy.

Fears of a second wave leading to further restrictions on people’s movements and activity are certainly affecting confidence today, but we are not making new lows – yet. Second wave and lockdown fears have really hit travel & leisure stocks this morning in particular.

Nevertheless, the broader landscape for equity markets remains supported by monetary and fiscal stimulus. Bond yields are negative in real terms right along the curve, earnings should recover as the economy picks up, albeit gently, whilst central banks are offering direct support to equities through the purchase of corporate bonds.

Meanwhile, in the US we know that a stimulus package is coming – the question is only really one of timing and scale. But another 10% of GDP should not be discounted by equity markets. A bit of pre-election fright could see a snap back, and arguably markets are not pricing for the volatility that occur around the election accurately. Having said that, fears of a disputed result may be overblown.

For the time being ranges are holding – though there is some heavy selling today amid the risk-off mood that may see these tested. European stock markets ticked lower on the open on Thursday, with the FTSE 100 heading back towards the low end of its range around 5,800 having broken the 50-day SMA at 5,983.

The Dax was also down around 2% in early trade to test the Oct 5th lows at 12,730, and the Stoxx 600 was off the most since September 21st.

These are sharp moves lower today and we need to watch whether we break out of the trading range – particularly on the FTSE where there is a significant degree of uncertainty over Brexit to make investors wary of exposure to the UK despite it being undeniably ‘cheap’. 5,778 is the low made on Sep 4th which has not yet been tested – a failure to break under will suggest the range is solid and suggest a push back to 6,000.

However we cannot ignore that the index keeps making lower highs and comes back to test lows around 5,800 on a number of occasions – knock hard enough and it could come crashing down.

We should also be prepared to see much stronger correlation between the FTSE 100 and GBP; that is, the two rising together if a deal is done, and falling together if a deal is not done, despite the recent inverse correlation related to the predominance of foreign earnings on the FTSE 100 meaning a weaker pound is positive for the market.

Traditionally there has been a tighter correlation and sentiment towards the UK as a whole would be a major factor driving both in tandem.

Stocks on Wall Street fell – the S&P 500 did indeed close under 3,500 at 3,488 and this could see a retest of the 50-day SMA at 3,393. The Nasdaq dipped 0.8% to 11,768 – first real test comes at 11,600 before the 50-day line at 11,438. The Dollar index found some support from the 50-day SMA at 93.30 but faces near-term resistance at 93.70. For now, it’s trapped between the two – which way will it go?

Earnings season continues and interest rates seem to be the emerging story of this quarter’s bank updates. Q2 was all about trading income and loan loss provisions; Q3 is all about the collapse in net interest income.

It should come as no surprise that US banks are struggling with ultra-low rates, but there has been a significant drop in the core earning capacity of banks this quarter that cannot be masked by strong trading revenues. Bank of America beat on the bottom line but missed on the top. Net income came in at $4.9 billion, or $0.51 per diluted share, which was a little ahead of the $0.49 expected and down 16% on the year.

Oil got some support after API inventories showed a larger-than-expected draw on inventories of 5.4m barrels. Gasoline stocks were –1.5m, distillates –3.9m. Stocks are Cushing, Oklahoma rose by 2.2m, though we should note there were likely some significant distortions to the data as a result of hurricane-related shut-ins along the Gulf of Mexico. WTI (Nov). EIA inventories due later today expected to show a drop in excess of 2m barrels.

On tap today: earnings from Walgreens Boots Alliance and Morgan Stanley. The big question is how is Morgan Stanley’s wealth management division cushioning any drop in trading revenues? US initial jobless claims later expected to come in at 810k vs 840k last week.

Election Watch

With Biden leading so handsomely in the polls, the market is apparently very confident of a Democrat win. This is leading to the correct assumption that the Senate is where we should be looking, as the race here will determine to a large extent how much of his agenda Biden could get through the legislature. A GOP-controlled upper house would tie his hands.

Current polling indicates it’s a toss-up in a number of states – Georgia, the Carolinas, Iowa Michigan, Montana and Maine, so the eventual make-up of the Senate is tough to call. Biden still leads by 9.2pts nationally, though this has dropped from yesterday’s 10pts.

In battlegrounds his lead has dipped slightly to 4.9pts. At this stage in 2016, Trump was behind in the key battleground states by 5.4pts. Still all to play for – don’t write off the President.

Chart: FTSE 100 heading for new low? Watch the bearish MACD crossover.

FTSE 100 index