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LONDON: Big investors are bracing for this summer’s stock market rout to extend into the autumn, fearing turmoil caused by U.S. recession fears and the Bank of Japan catching currency speculators off guard will trigger a wider wave of selling.
A sudden reversal in crowded stock and foreign exchange trades that led to a vicious cycle of falling prices, market volatility and hedge fund selling has eased, with global stocks up nearly 2% so far this week.
But asset managers overseeing hundreds of billions of dollars in investments say they are more likely to continue selling stocks than to buy back in as signs of weakness in the U.S. job market and global consumer trends lower the bar for a market aftershock.
Investors would normally respond to the sell-off by betting on a recovery, and the buy-the-dip mentality has been replaced by fear.
“This is now more than just a big financial market accident, as we could perhaps describe last week’s events as. It’s much broader than that,” said Mahmood Pradhan, a former deputy managing director of the International Monetary Fund and head of global macroeconomics at the research arm of Amundi, Europe’s largest fund manager.
He expects investors, who have cut stock positions and increasingly moved into cash, to remain cautious, according to Bank of America.
Michael Kelly, head of multi-asset at PineBridge Investments, which manages about $170 billion in client money, is among those cutting his fund’s stock market holdings.
“It’s going to be a very, very volatile situation over the next two months,” he said.
He added that the first U.S. interest rate cut is expected next month, but that may be too late to save the economy.
Investor expectations for global growth have fallen to their lowest in eight months.
Who will be the next seller?
A weak U.S. jobs report and a surprise rate hike by the Bank of Japan led to a global stock sell-off, volatility-linked and trend-following hedge funds heading for the exits and anxious investors piling into government bonds.
The Bank of Japan’s rate hikes have unwound billions of dollars’ worth of profitable trades, in which speculators borrowed yen cheaply to buy high-return assets such as U.S. technology stocks.
JPMorgan estimates that about 70% of carry trades have now been unwound. But flows tied to yen-linked positions are hard to measure, and Amundi’s Pradhan said the prospect of further unwinding makes people very risk-averse.
Gerry Fowler, head of European equity strategy at UBS, said the hedge fund sell-off may be over, but slower-moving mainstream investment managers typically take four to six weeks to adjust their portfolios.
Mary Dressak, multi-asset portfolio manager at Edmond de Rothschild Investment Partners, said these fund managers may be the next to sell, but she will decide whether to sell based on economic data.
While she thinks a major slowdown in the U.S. economy is unlikely, she is not buying stocks, preferring put options, which pay out if the market falls, thereby protecting against stock losses.
Pension funds will also further sell equity exposure and rotate into fixed income, Goldman Sachs strategist Scott Rubner said in a note, adding that the second half of September was Wall Street’s worst period of the year since 1950.
turmoil
Paul Eitelman, chief U.S. investment strategist at Russell Investments, said another weak U.S. jobs report could spark a new round of volatility.
Other market risk events include a speech by Federal Reserve Chairman Jerome Powell at the annual Jackson Hole central bank conference next week and an earnings report from artificial intelligence giant Nvidia on August 28.
“Even if you think it makes sense fundamentally, volatility makes it difficult to add exposure,” said Arun Sai, senior multi-asset strategist at Pictet Asset Management.
Fund managers’ risk mandates often prevent them from buying stocks when prices fluctuate widely.
The VIX gauge, which measures expected volatility for Wall Street’s S&P 500 and its European counterpart, hit multi-year highs last week before retreating, but the indexes continue to flash warning signs.
VVIX, another options market indicator that rises when traders expect volatility in the VIX itself, is currently trading above the 100 mark, suggesting the wild market swings are not over yet.
“Until you see VVIX break below 100, you should be watching it very closely. That’s the key indicator right now,” said Stuart Kaiser, head of equity trading strategy at Citi.
(Additional reporting by Nell Mackenzie; Editing by Dhara Ranasinghe and Kirsten Donovan)
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