The trade of being long fixed income and credit and higher quality yield in the equity market continues to work well globally. One just has to look at the daily chart of Johnson and Johnson in the US, which pays a meagre 2.63% yield, yet investors are compelled to hold because it’s rated AAA (the highest investment grade rating).
The observation central to the current investment landscape is subdued implied market volatility (watch the ‘VIX’). When you consider that over $10 trillion of government debt globally now commands a negative yield, investors want to be paid to be in a position and despite elevated valuations, equity looks relatively attractive. Too many valuations mean very little and momentum trading rules.
It seems that as long as implied volatility stays low then this macro trade will not change. The question is what will alter sentiment and cause volatility to spike? It doesn’t look like it will come from oil, which continues to push higher, with the overnight move into $51.62 largely a result of a 3.23 million drawdown in US inventories. The UK referendum is clearly the red flag and judging by GBP/USD one-month implied volatility, which remains close to the highest since 2009, traders are expecting a huge move in the pound. I still stand by the view that the UK will remain part of the EU, but David Cameron has hardly brought his A-game and the ‘Leave’ camp have polled better of late. The day of the 24th June promises to be a very interesting day in Asia when the polls are announced. So while GBP will be thrown around, it’s interesting to recall FTSE futures re-open at 10 am (AEST), so this will get plenty of attention.
The US election is a clear event risk yet causes absolutely no angst, perhaps because it is a number of months away. However, from an outsider’s perceptive, the unfolding story is incredible. Bernie Sanders refuses to concede, thus allowing the Democrats to galvanise and show cohesion, and his supporters bitterly suggest they will vote for Trump or spoil their ballot. Hilary Clinton is under FBI investigation and Donald Trump is aggressively defending himself against his comments around the ethnicity of Judge Gonalo Curiel. It’s a truly bizarre situation, yet traders don’t know how to trade, despite the betting market still giving Trump a higher chance of becoming president than the UK leaving the EU. Are we reaching a point again where investors have to become political commentators as well? I feel this is certainly coming and the impact of a Trump victory (although not my base case) should send shivers down any USD bulls’ spines. Janet Yellen is watching her every step.
Japan remains my key point of contention. While the market scream out for clarity on a further fiscal stimulus, the market remains sceptical on the Bank of Japan’s current inflation outlook and recent surveys in Japan see a 79% chance of easing by July. I remain sceptical on further JGB purchases, although I wouldn’t rule out buying of ETFs (as soon as next Thursday), as its really unclear what further monetary policy stimulus will do in Japan other than accelerate the inevitable. That being markets truly gives up on the notion that monetary policy in Japan drives inflation expectations.
All this being said, these factors and thematics are not to concern the open of the Asian markets and we expect a modestly stronger open on the ASX 200 at 5380. The top of the recent range of 5400 beckons, although my preference is a fade any rallies over the next few days into 5420. BHP should open around 1.5% higher, with a flat open for financials. Expect the energy and material space to perform nicely.