By Mark Melin
Saddled in between a U.S. Federal Reserve that recently indicated in Wednesday’s FOMC meeting rate hikes might be put off, leading some to point to weakness and confusion, and a June 23rd Brexit vote that has shockingly left one lawmaker dead in the region, sits the stock market. With six days of stocks trading lower, The McClellan Market Report thinks when the dust settles after the Brexit vote a mean reversion may occur.
The McClellan Market Report chart
FTSE 100 and Euro Stoxx 50 taking a reasonably equal beating ahead of Brexit
The scare tactics surrounding the Brexit vote have been beating down the FTSE 100, which was trading at 6301.52 on June 8 and today is trading at 5950.48, down 6.6%. Taking almost an equal beating is the European Euro Stoxx 50, representing broader European exposure. On June 8 it was trading at 3019.76 and is currently priced at 2829.30, down nearly 6.7%. Some expected to see a more material relative value spread between the two markets but that has not materialized on a short term basis. Watching this spread after the vote will be an interesting benchmark.
The UK currency has made a reasonably significant move relative to the US dollar, 1.4504 and today is trading at 1.4243, down slightly near 1.8% as the dovish move out of the Fed could be hurting the greenback and tamping down the relative value currency spread. For this reason, the pound / Japanese yen currency pair is more interesting if realistic reflection. Trading at 155.173 on June 8, it now trades at 148.589 a few days later, down 4.4%.
But the real action is not leading up to the vote, but what happens afterwards.
The McClellan Market Report chart
After Brexit vote, watch for investors to think things may have been “overdone,” particularly when trading US assets
“My expectation is that the market is going to realize that its fears over Wednesday’s FOMC meeting announcement and next week’s Brexit vote have gotten a bit overdone,” The McClellan Market Report stated. “The Presidential Cycle Pattern still shows tops ahead of us for stock prices, and so this oversold condition should allow the market to rebound strongly up into those tops.
A Brexit mean reversion play in US stocks, that particularly might be interesting when using in the CBOE VIX index to express a market view. The VIX has significantly diverted from its moving average mean, while the S&P 500 has not. Such reasonably direct correlations tend to correct over time and can point to relative value trades.
Comparing the increasing usage of the search term “Brexit” relative to the climb in the VIX, the report notes the correlation and thinks it might be a touch extended. To model near term market reaction, look at the recent “Grexit,” which started the vernacular on the topic.
“At some point in the past, the hoopla and worry over Greece faded, and investors got back to normal business. And at some point in this current period, we’ll see a similar climax,” the June 14 report advised subscribers. “That’s a whole lot of fear that has been ginned up quickly.”
Fear asset gold shows futures used for hedging diverging from mining stocks, while McClellan says avoid the crowd in bonds
Gold is normally a “fear” asset and an oddity was noted. The report noted a divergence between the price of gold and gold miners. The futures held firm but the miners dropped in value.
The report didn’t specify this, but sometimes this divergence is an indication of hedging interest, as the futures are typically for hedgers but the mining stocks are for investors.
Looking at price oscillating indicators, the report was looking for a lower price trend persistence in gold stocks. “A breakdown move from here would reveal last week’s push to a higher high to be a failing effort, leaving gold stocks all the more vulnerable to a larger price drop.”
The report also notes that “the crowd” is piling on the long side of T-Bond prices “and naturally that means that we should think the opposite.”
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