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Trader thoughts - the long and short of it

There was always a worry that sentiment had become a little crazy, with a number of red flags being highlighted by traders and strategists.

Market data
Source: Bloomberg

We talked last week about the ability for traders and investors to look at hedging strategies. The saying ‘hedge because you can, and because it’s cheap, and not because the market forces you to do so’ is seemingly in play. Here we can see implied volatility in the FX market moving higher. This is also the case in the bond market and the equity market, with implied S&P 500 volatility (or the “VIX” index) pushing into the 13% level, with traders increasing the demand for put options and downside portfolio protection. A break in the VIX index of 14.5% this week seems a tall order, but should it happen, it would promote a greater move lower in the S&P 500 and the other various US equity indices, as well as affecting sentiment in other global markets.

As we look around the markets for leads in Asia and it does feel like the bears are getting a better say. However, the buy the dip crowd have once again been prominent, with the Dow trading sharply lower by 3:00am AEDT and towards 26,452, while the S&P 500 fell to 2854 (-0.6%), although price has moved back towards 26,537 and 2863 (-0.3%) respectively at the time of writing. It seems, that with around 25% of the S&P 500 market cap set to report earnings on Wednesday and Thursday alone. Investors don’t want to be underweight if the trend of beats continues and they can squeeze further life out of the market and help generate alpha. Let’s see how the land lies once earnings are in the price and out of the way, that said, for now, the trend is higher and that still needs to be respected.

Apple has found good sellers ahead of its earnings numbers this week on reports (source: Nikkei) it is to halve Q1 iPhone production targets and this had reverberated through the semi’s, with corporates leveraged to the iPhone supply chain struggling. We are also seeing weakness coming into market darling Caterpillar, which has basically been an incredible proxy for all things emerging markets and if long, I would be running stops through the 3 January low of $155.40. It’s no surprise to see the EEM ETF (MSCI emerging market ETF) lower by 1.3% and this needs to be watched as the ETF has had a huge move and could be subject to mean reversion.

Boeing has been a huge contributor to the moves in the Dow especially through 2017, but again this market leader is struggling to regain its upside momentum but is finding bids into $331, so this support needs to hold. There has been indecision to push financials higher, with the XLF ETF (US financial sector ETF) basically unchanged despite a further sell-down in US fixed income markets, with the US 10-year Treasury moving four basis points higher to 2.70% and eyeing the 2.75% level I have been keen to focus on. Certainly, the moves in the global bond markets are getting noticed by equity traders. However, I don’t see them at levels that should genuinely promote risk aversion just yet. Of course, it’s also the pace of the sell-off that needs to be considered. As is the focus on higher inflation expectations and if inflation expectations don’t move higher to the same extent as nominal bond yields, then the result is higher ‘real’ yields.  And this, especially if it comes with a turnaround in the USD, represents a tightening of financial conditions and would be bad for risk sentiment. This would suggest looking aggressively at shorting emerging market assets, as a trade.

So with the USD eyeing the start of a tactical counter-rally, and where we see the USD index is gaining 0.4% on the session, we can see US data has started to roll in for the week. At 12:30am AEDT we saw the December PCE (personal consumption expenditure) print coming in as expected at 1.5% (+0.2%M/M), with personal spending and personal income printing 0.3% and 0.4% respectively, so good data but all very much in-line. While there will be a focus on Trump’s State of the Union speech, the USD index has scope this week to push towards the 17 January lows of 89.85, although that could offer better levels for USD bears to regroup and there are plenty out there looking to sell any counter-rally. EUR/USD has found buyers off the earlier low of $1.2336 and is looking like it will close above the 5-day exponential moving average (EMA), which I see as a loose trigger for a deeper move into $1.2200 to $1.2100. The monthly chart offers great perspective, where we can see the pair finding sellers at both the 2008 downtrend and the 200-month average, so this poses a trading consideration and clearly, the $1.2500 to $1.2432 area is key here. An upside break and one suspects we are to see a far longer-term move towards $1.4000, while a rejection could mean the weak USD move could be over.

USD/JPY has pushed a touch higher into ¥109 and has some scope this week to push into ¥110/50, but it is the USD/CNH and USD/CNY that is most influential. Clearly, the pair is putting in a base and any moves higher will push the broad USD higher. This is true of AUD/USD as well which is eyeing moves in USD/CNY, and where price is eyeing a break of the September highs of $0.8125, which could put a target of $0.8450 in play. That, despite the pair being ‘expensive’ on a number of valuation models for the first time in a while. NAB business conditions are in play at 11:30am AEDT, but unlikely to move the dial to any great capacity ahead of tomorrow’s Q4 CPI print.

So, aggregating all the known news, which also includes some headwinds for energy and material stocks, with oil lower by 1% and gold and silver finding sellers on early signs of a USD turnaround. At this stage, we are seeing Aussie SPI futures 17-points lower from the ASX 200 close (at 4:10pm AEDT) and with our fair value weighting, we are calling the ASX 200 to open at 6054 (-21 points), so a soggy open expected.

FMG gets attention with production numbers due and some of the heat coming out of the price of late, although spot iron ore closed largely unchanged. Banks have no real clear lead and should stabilise the market to an extent, although we should also case our eyes on moves in the Chinese equity markets and Hong Kong too, as we have seen some of the heat coming out of these markets after a huge run.

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