Lengthy Sell-off Tumbling Into a Fatal Crash? Fret Not, It Is Only Part of Profit-Taking

KEY TAKEAWAYS: 

  • The global sell-off last Tuesday was likely the consequence of profit taking rather than the beginning of a new crisis 
  • The profit-taking frenzy was triggered by a series of unfortunate events: Portfolio rebalancing before the end of Q3, the coronavirus resurgence, the major leak on institutional money laundering, the absence of a promised stimulus package, heightened geopolitical tensions, etc.
  • There is no cause for panic: When this sell-off ends, a more balanced, albeit slightly bearish market will emerge

Last Monday, a number of risky assets were rapidly sold-off across the board. Cryptocurrencies, which lie outside of the purview of the traditional financial world, seemed to have been leading the charge ahead of the stock markets. On Sept. 20, the price of Bitcoin dropped below the $11k mark, signaling the potential of a more significant drop if the trend of global risk aversion continues. However, Bitcoin demonstrated more resilience compared to other cryptocurrencies, with strong resistance bolstering the price back above the $10k mark.

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Sourse: Bybit Insight

What triggered the sharp sell-off? Well, there are several possible explanations. 

Firstly, risky assets soared too high, too quickly. They were bound to expect a correction at some point in time. 

Secondly, with so much economic uncertainty, it’s likely that global investors would have wanted to lock in profits before hitting the next roadblock — the U.S. presidential election this coming November. 

The stock market has been overcome with hubris since the end of July. With 80% of the remaining options set to expire in two weeks, the put-to-call ratio fell to a historic low, implying that the market entered a state of “euphoria”. Mid-September marked the end of the first round of correction, ensuring that the market was no longer in the same state. The put-to-call ratio retreated back to its normal range, and most options should have expired by last Friday. 

In the equity market, JPMorgan Chase recently claimed that pension and sovereign wealth funds are expected to offload $200 billion in equities in order to rebalance global portfolios. The massive offload is expected to offset short-term price hikes that could potentially destabilize the market. This might just be the most negative quarterly market adjustment since the pandemic hit. Coupled with a sharp decline in market depth, the rebalancing might even hold back U.S. equities before the election. 

Institutions tend to adjust portfolios each quarter to maintain their target asset allocation. However, what was expected to be a normal adjustment has evolved into a conflux of macro changes that subsequently triggered a sharp sell-off in global markets. However, there is a silver lining in that it’s highly unlikely that there will be another market rebalance before the end of September. 

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As we previously mentioned, the U.S. Congress is unlikely to pass any stimulus package before the election, due to irreconcilable schism between the Republicans and the Democrats. The death of Supreme Court Justice Ruth Bader Ginsburg has cast new uncertainties on the legal battle over postal ballots amid heightened partisanship and the COVID-19 pandemic. Further conflicts arose when the Republicans moved to swiftly replace Ginsburg, while the Democrats were pushing for a delay until after the inauguration of the next American president in January. The discord intensified an already contentious divide, and makes it less likely for Congress to work together on a stimulus package.

Amid political uncertainties, the faith in institutional finance has once again been shaken up by the leak of the FinCEN files, which revealed some of the darkest and most guarded secrets of the international banking system. The FinCEN files presented evidence that the international banking system had been facilitating suspicious transactions of up to $2 trillion from 1999 to 2017. More than half of the suspicious funds were passed through Deutsche Bank. The sudden and unexpected leak deflated the stock prices of top banks, dragging down global equity indices.

Source: CNBC

Concerns over the increasing number of COVID-19 cases continues to dampen market prospects. Countries such as the U.K. are pondering the possibility of a second lockdown. The fear plagued the U.K. stock market, wiping out more than 50 billion pounds ($64.28 billion) in shares. The FTSE market was down 3.4%, with airlines, travel firms, and hotel groups leading the rout. However, the worst is yet to come. Speculations over the coronavirus thriving in colder conditions will likely drive the market into a frantic downward spiral. 

The recent geopolitical tension in Asia could also be a ticking time bomb. However, we are less inclined to consider it an immediate threat, at least in this instance. Similarly, we do not see much liquidity risk for the time being, as liquidity indicators such as Libor – OIS, FRA – OIS and credit spreads, notwithstanding slight setbacks, remain far above the level of March’s liquidity crunch. 

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While all eyes are on the DeFi space, BTC remains surprisingly more resilient to macro changes. With real money pouring into the BTC markets, such as MicroStrategy’s hefty investments of over $400 million, the price should be able to withstand any short-term corrections. BTC’s price could be further bolstered if geopolitical risks continue to mount in Asia. However, it’s doubtful that it will see a significant increase before October 15, the expected date of deliberation following the arduous Mt. Gox legal case.

In conclusion, we see the sell-off as a sign that investors are pulling their profits rather than the signal of imminent crisis. Despite macro indicators pointing to a long-term bullish run, we remain skeptical that the market could rally any upward momentum before the election.