Volatility returns with surge in new Covid-19 cases

Risk assets are being sold off sharply early Monday following last week’s return of volatility. After dropping below 24 in the first week of June, the CBOE’s VIX almost doubled on Friday, reaching a high of 44 before settling at 36. The broad shift in mood was sudden on Thursday with US stocks experiencing their biggest declines since mid-March. The rally, driven by monetary and fiscal stimulus, suddenly appeared on shaky grounds as if investors realised they can no longer be detached much further from economic fundamentals. But once again, the surge in Covid-19 cases was to blame.

The road ahead is likely to be bumpy. There is no clarity on economic growth projections, earnings expectations and most importantly, the pandemic path. The resurgence of coronavirus cases in Beijing, parts of the US and Japan as economies further release their lockdowns is sparking fears of a second wave, and without a vaccine in hand, the second wave could be more threatening than the first.

At the time of writing, the Dow Jones Industrial Futures Index has plunged more than 800 points, indicating sharp losses for the first trading session of the week. The beneficiaries, as usual, have been the US dollar and the Japanese Yen along with US Treasuries. It seems investors are running for safety as the tranquility in markets has come to an end.

Fear of missing out or ‘FOMO’ could turn into regret aversion where investors prefer to stay out of markets, so it will be interesting to monitor sentiment in the days and weeks ahead. Cyclical sectors, especially Energy, Industrial and Financial stocks will be hit the most as they were the latest drivers of the equity rally.

Traders will need to monitor the term ’second wave’ very closely as it may become the key driver for asset classes.