The stock market Brexit bounce is likely to be short-lived, says a report from UBS sales trading desk. On a technical basis, wave patterns could take stocks higher in the short term, but a gravitational pull might take place near the major political conventions in July.

Brexit sell-off generated fear, but not panic

The Brexit sell-off that occurred mostly on Friday and Monday did technical damage, according to the independent views of Michael Riesner and Marc Muller on the UBS sales trading desk. Not only was the upper end of the 2120 / 2025 near term trading range broken, but the 200-day moving average was violated.

In the aftermath of Brexit, there is “initial fear, but no panic,” the June 28 report noted. The two-day sell-off may have been overdone in the short term and now the longer game may play out. Initial spikes in SPYDER S&P 500 index related volume are indicating near-term “exhaustive signs” among sellers.

“We shouldn’t be too far away from at least a bounce later this week,” they wrote. The stock market rally could last until just after the 4th of July holiday in the US, and then be cautious. “I think it is too early to call a bottom.”

Riesner and Muller look at “fresh short signals” in their indicators, a series of breakdowns on the macro side as well as weakness in key sectors including banks, transports, biotech, semiconductors. “A bounce should be short in price and time followed by further weakness into deeper July.”

Watch for a technical sell off in July — a continuation of a larger 2015 bear market move

It is that forthcoming move lower that investors and traders should watch.

During the Brexit exit, some bank analysts were modeling a 27 print on the VIX. Some independent researchexpected a 29 level to be the lower end of the Brexit trading band. Riesner and Mueller expect to see a VIX print in the 31 to 32 level after a bounce of the 16.7 region. This morning the VIX was trading near 16.8.

Driving the VIX higher will be stocks moving lower. “We think it is just a question of time to see 2025/2020 breaking, which would imply further weakness towards 2000 to 1960 with risk to undershoot towards 1928 into July.”

The key driver to watch is a test of the 2025 / 2020 levels. A break again of these levels near term “triggers a new short signal in our cyclical model.” Such a situation “implies that an imminent breakout in the US market is off the table.”

Not factoring in the fundamental equation, Riesner and Muller see this as their base case scenario. It points to a “complex wave 4 of a larger degree” that will include volatility. The analysis does not consider the Brexit sell-off as a singular event. The technical analysis draws comparisons to more important market moves that occurred in January and February were not the lows of a bear cycle that began in 2015, they said.

UBS sales desk – British pound might see bounce, but remains a weak currency

After a stunning decline post-Brexit vote, watch for a bounce in the pound, the report predicted. While 1.40 was a key support level, the 1.3120 level could be the location for a bounce in the British currency. But the bounce could be short-lived, as more weakness is expected going into 2017.

“So as long as we do not see a re-break above 1.48 we think that the adjustment phase in sterling will last longer than just 2 sell-off days,” they wrote. The pound sterling could remain a short-basis currency into the first half of 2017. “A break of 1.3120 would imply further weakness towards 1.20 to worst case 1.11, which we see as a potential target into later 2016 and into early 2017.”

The UBS sales desk technical analysts see a strong dollar projection remaining intact, but trading in a range. “As long as we do not see a new major US Dollar breakout (we think it is too early for this move) we see the SPX just trading in a volatile sideways trading range instead of expecting any kind of melt down scenarios!!”