by Chris Weston, IG
Volatility continues to show its hand, although this could be the new normal through Q1, as markets continue to grapple with falling inflation, spiralling commodities, crazy bond yields, political uncertainties and ultimately a market that feels central banks have no juice to meet their mandates.
Statistics don’t lie and while we have seen the S&P 500 rally for six consecutive years, you have to go back to the late1800’s for the last time the US benchmark saw a seventh consecutive year of gains. Whether we see the S&P 500 break into unchartered territory this time round is unclear, although sell-side strategists will of course tell you markets are going up and that is thematic with the consensus target of 2,228 (and a potential gain of 10%).
Intel to break-out of its recent trading range?
The current Q4 earning season in the US therefore is really so important. Naturally, the market will react to the earnings numbers and guidance, however listening to CEO’s on economic trends around housing, the consumer and manufacturing is so important. Forward order demand for resource players and how low oil could impact their business mean there is also in view, therefore, there is really something for everyone, not just equity traders.
Watch numbers today from Intel, Bank of America, Schlumberger and Blackrock. I am keen to see if the double bottom on Intel at $35.33 to $35.26 can hold, as this is a stock that has performed well and has low short interest and a break here could set a new trading range.
Asia has been mixed today with Japan finding solace from a shocking machine orders print, therefore solidifying the idea that the Bank of Japan will probably have to put its foot down a little more. China is seeing modest gains, while the ASX 200 is lower after factoring in the weaker US lead.
It seems the Chinese market saw some relief from the December financing numbers.
The concern I have is that if you look at the strong increase in the aggregate financing figures (at RMB1690 billion), new yuan loans (provided by the larger banks) made up 41% of the total financing figure, down from 74% in November. This suggests the shadow banks had a very active December extending credit into the economy; hardly thematic of deleveraging. A 1.2% decline in their foreign currency reserves also works against those who feel the yuan is set for a sizeable crash this year.
Copper and oil futures have also seen some short covering and are nicely higher in relation to yesterday’s ASX 200 cash market close. With this in mind, you could make a case that resource-listed names should have seen some reasonable short-covering today. Not the case, although it is supporting the AUD to a degree and this tells me that local traders and investors see the move as nothing more than a dead cat bounce. There is so much ill-will towards resource names right now and while some would see this as a perfect place to invest (think contrarian) this mind-set works well if you believe governments and central banks can step in to fix the issues.
Strong Australian jobs report, but the RBA should still cut in March
The Reserve Bank of Australia are one of the few central banks that can still affect monetary policy through the use of interest rates. However, today’s December Australian employment report certainly isn’t thematic of a central bank about to cut rates twice over the year (which is what the swaps market is basically pricing in). 41,600 full-time jobs being created is a strong number, but a 0.1% rise in the participation rate, and importantly also the employment to population ratio (to 60.8%) has made this even more robust.
The main issue is the unemployment rate at 6.1% is still far too high, but for now the numbers are keeping the AUD bears at bay.
Short EUR/AUD (A$1.4367 at the time of writing) looks compelling in my opinion. Firstly, you are trading with the trend, which, of course, should always be the case. RBA rate cuts are largely in the price, although the Australian economy could be the big unknown this year and the RBA will not cut in February which the market is giving a 10% probability to.
On the other side of the equation, the market has seen a favourable ruling from the Advocate General of the European Court of Justice on Mario Draghi’s OMT (Outright Monetary Transactions) policy from 2012. This has all but cemented the view that the European Central Bank will pull the trigger and expand base money, in-turn buying government bonds in the secondary market.
For me though, €500 billion of ECB bond buying will do very little in terms of generating inflation and if we look at the swaps market inflation expectations in Europe continue to fall. €500 billion represents around 5% of GDP, which is in-line with the Bank of England when they started QE and subsequently ramped up the purchases to a much higher level. Hence, in my mind the ECB will have to go hard in the second half of the year.
With two-year bond yields already negative in over half of European countries and many five-year paper also so low, the question is, will we see German 10-year bunds trading below 30 basis points and onwards in the coming months? The ECB can’t be pleased to be buying assets that are simply so expensive.