A flight to quality

Capital preservation seems to be returning to global markets, and many of the positive trends of late are unfolding fairly rapidly.

The selling in US treasuries has reversed and turned into a flight to quality, with the US ten-year trading to 2.70% (down eight basis points on the day) and testing the uptrend drawn from the May 3 low. Traders are also buying JPY and CHF and clearly shying away from the USD, given its negative correlation to oil and gold, which seem to the driving force here.

Being long oil and gold is working, although traders don’t want to hold equities leveraged to these commodities today, highlighting the clear risk aversion. We’d caution in the short term on gold, given the failed breakout of the June 6 high of $1423.90 and subsequent move to $1417 today. It’s worth looking at gold in AUD terms, which is looking really strong having rallied 22% from the June 27 low, relative to gold in USD terms which is up 18% in the same period. WTI and Brent have found further buyers today.

The world is transfixed on Syria and rightly so given the Syrian foreign minister’s comments that its defence would surprise the world. This is a market where the bulls are happy to revert to the sidelines and watch the situation unfold, with social media playing a bigger role than ever in providing a first mover advantage for those wanting to adjust portfolios or take a short-term positions.

Talk around the floors in early trade was that Syria had evacuated its forces from a security base, with Jordanian forces are also clearing its borders with Syria. An hour or so later there were rumours that a rocket had actually been fired, causing AUD/USD to trade to 0.8926 and AUD/JPY to 86.52, although this has not been substantiated. It has to be said that UN inspectors are in Syria until Sunday, so there is some belief among traders that the US and its allies could hold off from potential action until then.

The fact that both Syria and Iran are responding and now saying any attack by the west would give them full justification to attack Israel is not helping sentiment either.

S&P futures have edged up a touch in Asia, although the tape in the cash market has been poor and short-term moving averages are starting to head lower in bearish alignment. The combination of poor liquidity and rather punchy headlines is never a good situation for stocks, and the threat of tapering has probably made the’ buy the dip’ crowd think twice about new longs.

The S&P 500 has retraced over 50% of the 9.7% gain seen during the June 24 to August 2 rally and is eyeing support at the 61.8% retracement of move at 1617. Today’s pending home sales report will be closely watched given a gain of 7.9% on the year is expected, and traders will be keen to see if this data release follows that of the new home sales, which of course fell over 13%.

Asian equities have generally been in reactionary mode given the poor European and US markets, but there has been some modest buying from the early lows. The same can’t be said though in the Philippines, with the market down 5.5% and at the lowest levels since December 2012; however in the forex space we are actually seeing buying (albeit modestly) in the Indonesian rupiah after yesterday’s collapse.

The Nikkei is the biggest underperformer (down 2.3%), while the ASX 200 is lower 1.1% at 5085 and predictable there is a better bid in staples and utility names. Interestingly, the Australian treasury auctioned A$800 million of bonds maturing in 2024 with a terrible bid to cover ratio of 1.7x, and perhaps this could be a litmus test ahead of the $98 billion of issuance being auctioned in the US this week in two-, five- and seven-year treasury bonds.

China has helped lift sentiment throughout Asia, with the Shanghai Composite falling 1.1% in early trade, before buyers moved in.

Valuation support is clearly present, with the index trading at 8.5x forward earnings, which is not just a sizeable discount to its long-term average, but also any developed or emerging market. The index is still in a short-term uptrend having rallied 13.5% from the June 25 low and has now retraced over 50% of the losses seen through May and June. Around 76% of the index has reported H1 2013 earnings, and 46% of companies have beaten on the EPS line, a slightly more modest 44% have beaten on revenue. However, earnings growth has been strong with 9.3% aggregate EPS growth seen, while the banks have seen 13.4% growth, which is certainly higher than what was expected a few weeks ago.

European markets look set to build on yesterday’s losses, although they could take some solace from the fact that China has reacted with calmer heads. The DAX looks set to break its two-month sideways pattern, with an open expected below the July 31 low of 8213, while the Italian MIB will build on the 6.3% pullback since Aug 16 and traders will be closely watching whether the Italian ten-year can also keeping pushing higher after putting on thirty basis points in the last couple of weeks.

EUR/USD looks range-bound and we would play the 1.3350 to 1.3450 range in the short term, with sterling taking centre stage today with BoE governor Mark Carney giving his first speech in Nottingham. We feel the market is modestly short sterling into this speech on the hope he will acknowledge the moves in short and long-term rates and could in theory talk about the tools at his disposal, such as turning on the QE taps again to bring down yields. EUR/GBP seems to be the market’s preferred cross given the recent European data flow, and 0.8650 can’t be ruled out in coming trade.

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