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The USD is modestly offered, despite US treasuries opening a touch higher and testing Friday’s high of 2.86%.
The calls for ‘correction’ have increased today from certain circles, and although there is no immediate smoking gun, a key concern seems to be the current elevated optimism and positioning in developed market equities. From a currency perspective, USD longs have been cut to $17.62 billion (from $21.62 billion the prior week), however, equity funds continue to record inflows, with a record 32 consecutive weeks of fund inflows. The major issue now has to be the complacency that is clearly being displayed by equity traders.
On Friday we saw a higher volatility index (VIX), but at 14.37% the index is only just above the years average of 14.08% and certainly well below the average over the last five years of 23.4%. Buying downside protection is cheap right now and with event risk ramping up through September and into October, you could make an argument that this index could be closer to 18% in the coming weeks. A recently released Buy-side sentiment survey by Morgan Stanley highlighted that conviction towards US equities stands at the highest level since February 2011, with 81% of institutional respondents now bullish. Money managers recommended asset allocation towards equities (as reported to Bloomberg) has hit the highest level since mid-2012, although at 50.90% still stands below the 60-65% recommended portfolio weighting through 2004-2007. Recommended bond allocation weightings have subsequently fallen from 40% in mid-2012 to 35% at present. The other issue which is being talked about is the level of leverage in the system with the NYSE margin debt as a multiple of US GDP per capita at the highest levels since 2007. Still, these factors don’t signal a new trend; but it is worth highlighting that many participants are now standing on one side of the ship, and when that occurs, often the ship can tip.
So despite the back up in US yields on Friday and again today, Asian markets haven’t seen too much negative price action, even China which is still trying to regain lost confidence from Fridays mini flash crash. It feels like the calm before the storm; however the buying we have seen in AUD today seems thematic that further macro funds have had to close out shorts, reversing some of their bearish China strategies.
Over the weekend, news that China saw price rises in 69 out of 70 cities has also been backed by measures to increase foreign investment. Net shorts on the AUD now stand at $5.7 billion, which is the lowest since June, however it’s worth pointing out that technically things are looking more constructive. AUD/USD hit a high of 0.9233 today; however sellers have kicked in at the 55-day moving average at 0.9229; with the pair having been below this medium-term average for the last 78 trading sessions. A closing break of 0.9229 would see the June 26 pivot high of 0.9345 come into play, where we would expect a good level of offers kick in. It’s also interesting to see the Australian ten-year bond pushing the June 24 high of 4.03%, where a break will see the highest yields since April 2012. The yield advantage over US treasuries has once again re-established itself with an 115bp premium, up from 96bp on August 1 and thus boosting the appeal of the AUD to foreign institutions.
It has to be said that despite a fairly average earnings season in Australia (with 34% of ASX 200 companies having reported and 53% having beaten EPS and 32% on revenue), the market is doing quite well. The fact that the market is only down 0.1% needs to be put into context; given 20.55 points came out of the market due to a number of firms (including TLS and CBA) going ex-dividend. It is also worth noting that volume has been good today, with $4.18 billion going through the market (at 15:00 AEST), some 16% above the same time on Friday, which in itself was a fairly solid day.
The market could be front running the idea that life with a majority government is becoming more of a reality by the day which could be helping. The other key talking point is the clear outperformance the market is having relative to that of the S&P 500, and we question exactly how much greater this outperformance will become if BHP (8.4% of the ASX 200) reports solid full-year earnings tomorrow and the S&P 500 can close below the 55-day moving average at 1254 and 38.2% retracement of the late June rally at 1652. Long ASX 200, short S&P 500 seems like a good trade.
With Japan up 0.4%, despite a huge blow out in its trade deficit, our opening calls for European markets haven’t moved too much throughout the day and look like they will see a modest fall on the open. Data is limited, although the Rightmove house price index fell 1.8% in August, with cable hardly flinching. The big corporate reports kick in tomorrow with BHP and Glencore Xstrata releasing earnings, so the European session will be back to watching bond yields again. Greece may fall in the spotlight again; with a German publication (Bild-Zeitung) saying Greece’s creditors could write-down debt after the German election. On another note, the election is shaping up quite nicely for Angela Merkel and her current coalition.