The Bull

Wednesday 26

July, 2017 8:40 PM



IG Research - The long and the short of it

IG Research - The long and the short of it

It appears the market has come alive with the dynamic of volatility, which will no doubt be welcomed by many of the shorter-term traders out there.

Share |

18.05.2017 08:13 AM

It appears the market has come alive with the dynamic of volatility, which will no doubt be welcomed by many of the shorter-term traders out there. That being said when so many global markets were at multi-year, if not all-time highs, you know there would be some pain being felt out on the floors today.

However, we do need some context. What we have seen has been a solid session of risk aversion, but is it the start of a trend lower in risk assets and a period of more elevated implied volatility, where we see the US volatility index (“VIX”) holding a 15 handle and perhaps moving into 20? That is yet to be seen and is seemingly going to be the question that will be discussed first and foremost today.

The answer to that lies in the source of the sell-off. Is this really about going as far as saying Trump is potentially staring at impeachment? This still seems such a high hurdle given the makeup of both the House of Representatives and Senate and the math needed to push through an Article of Impeachment. Importantly, Trump hasn’t actually been accused of any crimes yet, and while Article II of the US Constitution actually pushes out to “treason, bribery or other high crimes and misdemeanours”, the political analysts out there would still point to a very low probability of impeachment at this stage.

All eyes now fall on the House Committee hearing next Wednesday (Thursday 23:30 aest for Aussie’s), where former FBI director James Comey has been invited to testify on the allegations that Trump asked him to “let go” his investigation into former National Security Advisor Michael Flynn. At this stage, we don’t know if this hearing is to be public, but it is now the must-watch event and if public will attract massive ratings.

What we do know is this bout of risk aversion is certainly about a giant push back on the future of tax reform and Trump’s ability to deliver (anything) has been dealt a massive blow given the level and magnitude of controversies in play. We have heard Republican Senator Hatch (the second-highest ranking official in the Senate) disclosing “I don’t know if the health-care bill can be passed by August”, where of course the bill still needs to make it through the Senate.

One can make an argument that some are seeing signs that perhaps the patch of poor US data points isn’t as “transitory” as many expect and that global growth isn’t as healthy as expected. One just has to look at global car sales numbers in April, they literally have fallen in every major economy.

Either way, there are a lot of questions, a lot of speculation and a lot of noise about the US political scene and investors and traders do what know best in these times and rush for portfolio protection. The moves in financial markets have been brutal, not because of the absolute size of the move, but specifically because of the size of the move after a prolonged period of such subdued implied volatility. On a relative basis, this has jumped out at traders and given them a wake-up call that markets do indeed have a pulse.

The moves have been broad-based through FX and other markets. The JPY has rallied against every currency in the world, except the Haitian Gourde, Madagascan ariary and Tunisian dinar, so expect the Nikkei 225 to be hit pretty hard on open. The USD index has fallen 0.6%, but the selling has been most intense against the JPY and to a lesser extent the EUR. The implied probability of a June rate hike has dropped to 60%, and keep in mind this was in the high 80’s recently and this probability will be dictated to be moves in US equities from here. We have seen solid buying in US Treasuries across the curve, although the buying has been more aggressive in longer-dated bonds and therefore we have seen the curve (the difference between US two-year and ten-year treasuries) fall five basis points (bp) to 97bp and somewhat ironically, below where the yield spread stood on the day of the US election.

‘Real’ or inflation-adjusted bond yields have fallen sharply and of course, gold is going to benefit here and we have seen a strong move higher, with price pushing through the April downtrend at $1256. A closing break of $1264 and we should see a re-test of $1295. US equities have been sold aggressively, particularly small caps (the Russell 200 closed -2.5%), transports (-3.1%) and tech (NASDAQ -2.6%). The S&P 500 had its worst day since September, with 83% of stocks lower on the day, although we can still find pockets of strength. Implied volatility has predictably ramped up, with the VIX moving up a lazy 46% at 15.5. Emerging markets have been hit hard, with the EEM (Emerging market ETF) closing -1.7%.  I was bullish on this market two days ago, but price action has changed the dynamic and I would be cautious this market, for now.

One could make an argument that the ASX 200 should outperform somewhat today given we closed -1.1% yesterday, underperforming other Asian bourses and S&P 500 futures. However, our call today sits at 5715 and a fall of 1.3% is expected, but the important aspect is how Aussie traders deal with the open – will they continue to dump stocks after the unwind or sense this is overdone and bravely increase equity exposures? Our opening call includes the 12-points that come out of the market, with WBC going ex-dividend today. Banks, again are going to get chopped up and this is the time to short banks, as few will be buying and when the bid dries up the short sellers have a far better time, although they have to be agile as the hold period for shorting banks is usually short.

Materials actually have a far more constructive lead-in, with small gains in US crude and iron ore (both spot and Dalian futures), although BHP’s American Depository Receipt (ADR) closed down 0.9%. 

(Watching gold for a break of $1264 – the 61.8% retracement of the April –May sell-off and Feb high) 


Originally published by Chris Weston, IG
Archive
Markets
Index: Points Change Percent

PLEASE SUPPORT OUR SPONSORS, AUSTRALIA'S LEADING BROKERS:



© Copyright The Compare Group Pty Ltd. All rights reserved.