A recovery in US stocks on Tuesday could merely be the calm before the storm, according to one analyst who has warned investors to brace for a possible "Lehman-like" aftershock following Monday's broad sell-off.
The gloomy outlook from Nomura strategist Masanari Takada comes as the market has grown increasingly concerned over the fallout from a more contentious US-China trade row.
While some analysts have warned of rising recession risks, others have been less ominous in their forecasts that suggest more volatility in stock markets should be expected, amid an uncertain outcome to trade talks and a more hawkish Federal Reserve than investors had hoped.
Takada said he expected a spike in volatility to arrive in two waves, citing the sell-offs that historically occur in August and selling by hedge funds and trend-following algorithmic traders. The latest retreat out of equities signalled that the first wave of volatility has arrived, he said, noting that the Vix volatility index — known as Wall Street's "fear gauge" — has broken above 20.
"We would add here that the second wave may well hit harder than the first, like an aftershock that eclipses the initial earthquake. At this point, we think it would be a mistake to dismiss the possibility of a Lehman-like shock as a mere tail risk," he wrote to clients, referring to the collapse of the Lehman Brothers investment bank during the 2008 financial crisis.
Heightened tensions between the world's two largest economies triggered on Monday the steepest decline in US stocks this year. China allowed its currency to sink through a key threshold and halted purchases of American crops, ratcheting up a trade spat with the US after President Donald Trump threatened to impose a fresh round of tariffs next month.
The S&P 500 sank 3 per cent amid heavy losses in tech and financial shares. The index clawed back some of its losses on Tuesday, rising 0.6 per cent in afternoon trading in New York.
Takada said expectations for a substantial Fed rate cut would support a probable relief rally once the "first wave" has passed. But a recovery would be "no more than a head fake" before the next bout of volatility in late August or early September, he predicted.
"We read the current trend in sentiment as suggestive of both deterioration in supply-demand for equities and a sharp downward break in fundamentals," Takada said.
"Above all, the pattern in US stock market sentiment has come to even more closely resemble the picture of sentiment on the eve of the 2008 Lehman Brothers collapse that marked the onset of the global financial crisis."
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Written by: Matthew Rocco
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