A few weeks ago, Normura analyst Masanari Takada warned of an impending “Lehman-like” collapse in the stock mark. This week, he added some urgency to that warning.
“The U.S. stock market especially is facing its greatest test of the year thus far,” Takada wrote in a note to clients on Monday. Takada believes that low sentiment is poised to prompt “panic-selling by fundamentals-oriented investors and systematic selling by trend-following technical investors along the way.”
Takada’s view is one of the most pessimistic on Wall Street and is based on macro and quantitative data including flows from hedge funds and other big players, which is showing that sentiment is nearing its lowest level of the current market cycle.
“The correlation between sentiment then and now remains quite high,” Takada said, referring to the Lehman collapse. “Even the passing risk-on phase after the initial shock of the yield curve inversion (this month)… and the risk-off mood that struck on 23 August neatly track the pattern recorded in 2008.”
“If this uncanny resemblance between the two patterns continues to hold, sentiment could soon fall to a level not seen since December 2018,” he continued.
In early August, Takada predicted the first explosion in the CBOE Volatility Index, better known as the “fear gauge,” which shot up to its highest level of 2019 on August 5 when China let its currency drop to a level not seen since the financial crisis in reaction to the ongoing trade war.
This week marks the last week before the Labor Day weekend. Volumes are typically quite low at the end of August, which can lead to wilder swings in the market.
Takada also pointed out that the market performance over the past two weeks has shown an “uncanny resemblance” to 2008. Technical traders, including Commodity Trading Advisors, are already trimming their long positions “at an accelerating pace,” which could exacerbate selling in the near-term, Takada said.
“The continued liquidation of long positions in equities by trend-chasing investors could convince one global macro hedge fund after another that now is the time to start paring longs,” Takada wrote.
On August 14, the Dow Jones Industrial Average had its worst day of the year, losing 800 points as the yield curve between the 2- and 10-year Treasury notes inverted, which is widely considered to be an ominous sign that a recession is right around the corner. Since then, the yield curve has repeatedly inverted as the longer-term yields continue to fall on trade war fears.